tag:blogger.com,1999:blog-20929633983811630692024-02-23T02:04:07.775+08:00Options Trading BeginnerLet’s learn and understand options trading … from scratchOPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.comBlogger279125tag:blogger.com,1999:blog-2092963398381163069.post-29122641836280300242021-02-13T12:00:00.004+08:002021-02-14T14:03:48.842+08:00Avoiding the Risk of Ruin from a Draw Down<p><span face="Calibri, sans-serif">Having a sound
</span><span face="Calibri, sans-serif" lang="EN">money management strategy is very</span><span face="Calibri, sans-serif"> important in order to avoid the risk
of ruin from</span><span face="Calibri, sans-serif"> <span lang="EN">losing streaks and drawdowns.</span></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">However, please
bear in mind that although you might have implemented strict money management
rules, you still cannot avoid drawdown at all. Drawdowns are inevitable. <o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">Therefore,
you need to know how to stop the drawdowns, so as to avoid the risk of ruin and
allow you to survive a period of losing streaks and drawdowns. <o:p></o:p></span></p>
<p class="MsoNormal"><span face="Calibri, sans-serif">However, the
good news is, to stop a drawdown is simple. All you need to do is just stop
trading. That’s it!</span></p>
<p class="MsoNormal"><span face="Calibri, sans-serif">But, what’s next? What can you do when you stop trading?</span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif" lang="EN-GB" style="mso-ansi-language: EN-GB; mso-fareast-font-family: SimSun; mso-fareast-language: ZH-CN;">You can still
continue to monitor the markets, your favourite stocks and indicators. <o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">By not being in the markets, you will
be able to sit back and analyze the situation without the emotions.</span><span face=""Calibri",sans-serif" lang="EN-GB" style="mso-ansi-language: EN-GB; mso-fareast-font-family: SimSun; mso-fareast-language: ZH-CN;"><o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif" lang="EN-GB" style="mso-ansi-language: EN-GB; mso-fareast-font-family: SimSun; mso-fareast-language: ZH-CN;"> </span><span face="Calibri, sans-serif">Here are some of the
things that you can do while you stop trading:</span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif" lang="EN-GB" style="mso-ansi-language: EN-GB; mso-fareast-font-family: SimSun; mso-fareast-language: ZH-CN;"> </span></p>
<p class="MsoNormal"><i><span face=""Calibri",sans-serif">1) Make sure that you fully recognize
and understand all of the reasons that caused your drawdown. <o:p></o:p></span></i></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">There are 2
possible reasons:<o:p></o:p></span></p>
<p class="MsoNormal"><b><span face=""Calibri",sans-serif">a) Yourself<o:p></o:p></span></b></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">When you experienced
a drawdown, you should always look within yourself first and review your recent
trades or trading journal, to ensure that nothing has recently changed. <o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">Ask yourself questions,
such as: <o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">* Have you
been following your trading system/rules and manage risks properly? Did you
break or modify any of the rules knowingly or unknowingly? Did you “force” any
trade?<o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">* Any changes
in your trading styles recently? <o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">* Is there
any major </span><span color="windowtext" face="Calibri, sans-serif" style="text-decoration-line: none;">life</span><span face=""Calibri",sans-serif"> event that affects you, physically or
psychologically? <o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">* Any
distractions that hinder you from focusing?<o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif"> </span><b><span face=""Calibri",sans-serif">b) Market Conditions</span></b></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">Market
condition may affect the performance of your trading style/methodology.<o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">Sometimes,
there are some market conditions that are more favorable to your
style/methodology and give you a better chance to be profitable, or vice versa.
<o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">But when the
market changes, it becomes more difficult for you to trade in an unfamiliar
conditions. <o:p></o:p></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">When that
happens, you may need learn and understand the market condition better and be
extra careful / selective in your trading in the sector or stock selection,
market timing, etc. Sometimes, it is even wiser to stand in the sideline and
watch the market, rather than jumping in an unfamiliar market condition.<o:p></o:p></span></p><p class="MsoNormal"><span face=""Calibri",sans-serif"><br /></span></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif"> </span><i><span face=""Calibri",sans-serif">2) Once you have identified the causes
of your drawdown and made some plans / strategies / rules to tackle the
problems, you can start again by doing paper trading to test it. Remember to
keep records for every single trade you made in paper trading.</span></i></p>
<p class="MsoNormal"><u><span face=""Calibri",sans-serif">Note:<o:p></o:p></span></u></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif">You can find some useful tips for paper trading from the earlier article: </span><a href="http://optionstradingbeginner.blogspot.com/2007/07/5-tips-for-more-effective-virtual-paper.html" rel="nofollow" target="_blank">5 Tips For A More Effective Virtual / Paper Trading</a></p>
<p class="MsoNormal"><br /></p>
<p class="MsoNormal"><i><span face=""Calibri",sans-serif">3) When you’re consistently profitable
in paper trading for some time, you can then slowly start </span></i><i><span face=""Calibri",sans-serif" style="mso-bidi-font-family: "Times New Roman";">with real trades again to engage your
emotion into the trading. Start with small trades first. </span></i><i><span face=""Calibri",sans-serif">When
the trade is profitable, you can gradually and slowly increase your position
size. <o:p></o:p></span></i></p>
<p class="MsoNormal"><i><span face=""Calibri",sans-serif">If you encounter losses again, then
scale back in your trading, or go back to paper trading, if necessary.<o:p></o:p></span></i></p>
<p class="MsoNormal"><span face=""Calibri",sans-serif"> </span></p>
<p class="MsoNormal"><i><span face=""Calibri",sans-serif">4) Repeat the above steps until your
trading performance improves. <o:p></o:p></span></i></p>
<p class="MsoNormal"><i><span face=""Calibri",sans-serif">Remember to always keep records for
every single trade, including the notes about market conditions. Learn from the
past experiences, so that you can avoid the same mistakes and would be better
equipped to tackle the future drawdowns.<o:p></o:p></span></i></p>
<p class="MsoNormal"><br /></p>
<p class="MsoNormal">To view the list of all the series on this topic, please refer to:
<a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-position-sizing.html" target="_blank">Money Management / Position Sizing</a> </p><div><strong><u>Related Topics:</u></strong> </div><div>* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a> </div><div>* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a> </div><div>* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a> </div><div>* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a> </div><div>* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a> </div><div>* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>
</div><div><br /></div>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-42539707714856958472020-12-21T19:00:00.003+08:002020-12-21T19:01:58.061+08:00Things to Consider in Setting Money Management Rules – Part 3: HOW LONG YOUR CAPITAL CAN LAST<p><span style="font-family: inherit;">In
setting money
management/position sizing rules, you should also consider:</span></p>
<p class="MsoNormal"><span style="font-family: inherit;">1) How long
your capital can last, or <o:p></o:p></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">2) How long
your account balance will drop to the risk tolerance you’re willing to take </span><span style="font-family: inherit;">after going
through a series of successive losing steaks.</span></p>
<p class="MsoNormal"><span style="font-family: inherit;">The answers
to these questions will depend on:</span></p>
<p class="MsoNormal"><span style="font-family: inherit;">* The initial
capital/account balance<o:p></o:p></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">* How much to
risk per trade<o:p></o:p></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">* The
percentage risk tolerance (for Qtn 2)<o:p></o:p></span></p>
<p class="MsoNormal"><span style="color: black;"><o:p><span style="font-family: inherit;"> </span></o:p></span></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Suppose
your initial capital is $10,000. <o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><span style="color: black;">If
you </span>money management rule
is that you would risk maximum 5% of the <u>initial capital</u> (i.e. 5% x
$10,000 = $500) in each trade, your capital will be all wiped out after 20
successive losing trades.<span style="color: black;"><o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><span style="color: black;">Suppose
your </span>risk tolerance is
25% (i.e. 25% x $10,000 = $2,500), your balance will reach this level after 5
losing trades in a row.<span style="color: black;"><o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">Notice
that the above rule is different from what has been discussed as Option 2 in
the previous article.</span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><span style="color: black;">In
the Option 2, the m</span>aximum
risk in each trade is 5% of the <u>remaining account balance</u>.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">Hence,
with the initial capital of $10,000, after losing 5% </span><span style="font-family: inherit;">(i.e. 5% x $10,000 = $500) </span><span style="font-family: inherit;">in the 1</span><sup style="font-family: inherit;">st</sup><span style="font-family: inherit;"> trade, the balance will be $9,500.
Then, the 2</span><sup style="font-family: inherit;">nd</sup><span style="font-family: inherit;"> trade will risk 5% </span><span style="font-family: inherit;">of the remaining balance
(i.e. 5% x $9,500 = $475), </span><span style="font-family: inherit;">the balance will be
$9,025, and so on.</span></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Using
this rule, to answer the above questions is not that straightforward. However,
this rule is more common to be used by traders.<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Hence,
let’s try to formulate it.<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">Trade
1:</span><span style="font-family: inherit;"> </span><span style="font-family: inherit;">$10,000 x (1 – 5%) = $9,500</span></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Trade
2: $10,000 x (1 – 5%) x (1 – 5%) = $10,000 x (1 – 5%)^2 = $9,025<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Trade
3: $10,000 x (1 – 5%) x (1 – 5%) x (1 – 5%) = $10,000 x (1 – 5%)^3 = $8,573.75<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><span style="color: black;">Trade
</span><i style="mso-bidi-font-style: normal;"><span style="color: black;">n</span></i><span style="color: black;">: $10,000 x (1 – 5%) x (1
– 5%) x (1 – 5%) x …… = $10,000 x (1 – 5%)^</span><i style="mso-bidi-font-style: normal;"><span style="color: black;">n</span></i><span style="color: black;"> <o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">Putting
in a formula form:</span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgpBqgrQob2VGxE6i74jEka1u6ZejFmuuBk2-5RnfNepX82tXYybkItduxnkv04Y4zAtCg33brTRdmTCA61cs4Zq5kx8WoDhAQTzvCRWqY81FTQqBOk8jRsMK_opM5vGtRZsDGLPmNgME/s150/Formula_1.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="35" data-original-width="150" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgpBqgrQob2VGxE6i74jEka1u6ZejFmuuBk2-5RnfNepX82tXYybkItduxnkv04Y4zAtCg33brTRdmTCA61cs4Zq5kx8WoDhAQTzvCRWqY81FTQqBOk8jRsMK_opM5vGtRZsDGLPmNgME/s16000/Formula_1.PNG" /></a></div><br /><p class="MsoNormal"><span style="font-family: inherit;"><br /></span></p><p class="MsoNormal"><span style="font-family: inherit;">Where:</span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">C</span></i><span style="color: black;"> = Initial capital (Initial account balance)<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">R</span></i><span style="color: black;"> = % Risk for each trade<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">n</span></i><span style="color: black;"> = Number of trades<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">B</span></i><span style="color: black;"> = Remaining capital/account balance<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="color: black; font-family: inherit;">To
answer the above two questions, we need to solve </span><i style="font-family: inherit; mso-bidi-font-style: normal;"><span style="color: black;">n</span></i><span style="color: black; font-family: inherit;">, which can be done through the basic principles of logarithm, as
follows:</span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-Q7v_g_yX96uW_ZBzVABgXCKETW2NTSlk0G6MPHwvnNLVxpmJtqcs1cFWHWG1lBo3zYTcFfunV3d0jYgUkBfc4tQGe_o891BPEEBM6dkmXvYoOagg4R9GRN4NORmKa3CduxeLuRm7xvE/s245/Formula_2.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="111" data-original-width="245" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-Q7v_g_yX96uW_ZBzVABgXCKETW2NTSlk0G6MPHwvnNLVxpmJtqcs1cFWHWG1lBo3zYTcFfunV3d0jYgUkBfc4tQGe_o891BPEEBM6dkmXvYoOagg4R9GRN4NORmKa3CduxeLuRm7xvE/s0/Formula_2.PNG" /></a></div><br /><p class="MsoNormal"><br /></p><p class="MsoNormal"><br /></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;"><br /></span></span></p><p class="MsoNormal"><span style="font-family: inherit;">Please
note that, to answer Qtn 1, we CANNOT set the remaining account balance as
zero, as logarithm function will never touch zero line. Hence, we should assume
a certain amount, which is small enough and can be deemed as “no more money for
trading”.</span></p>
<p class="MsoNormal"><span style="font-family: inherit;">For
example:</span></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Assume
we deem $100 as small enough to approach a situation of “no more money for
trading”.<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Continue
with the above case, the values of each variable are:<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">C</span></i><span style="color: black;"> = $10,000<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">R</span></i><span style="color: black;"> = 5% <o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">B</span></i><span style="color: black;"> = $100<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="color: black; font-family: inherit;">To
find how long the capital can last, we solve </span><i style="font-family: inherit; mso-bidi-font-style: normal;"><span style="color: black;">n</span></i><span style="color: black; font-family: inherit;">:</span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_Q190yml3Rlyn6XWeL8S26sm3LfxF7lqajOR4M7D91wEPBg9QlLZKAWOD1YVk-VPYwosZeuzCKijQkc1UexsZypkLy90bO9eBvTxoCQYbkcBGL0mEoURxM79KmHh6ZPSE0fAeYY5F13A/s486/Formula_3.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="72" data-original-width="486" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_Q190yml3Rlyn6XWeL8S26sm3LfxF7lqajOR4M7D91wEPBg9QlLZKAWOD1YVk-VPYwosZeuzCKijQkc1UexsZypkLy90bO9eBvTxoCQYbkcBGL0mEoURxM79KmHh6ZPSE0fAeYY5F13A/s320/Formula_3.PNG" width="320" /></a></div><br /><p class="MsoNormal"><br /></p><p class="MsoNormal"><span style="color: black; font-family: inherit;">Note: Always round down the result.</span></p><p class="MsoNormal"><span style="color: black; font-family: inherit;">Likewise,
to answer Qtn 2 where the </span><span style="font-family: inherit;">risk
tolerance is 25% (i.e. 25% x $10,000 = $2,500), </span><span style="color: black; font-family: inherit;">the
values of each variable will be:</span></p>
<p class="MsoNormal" style="text-align: left;"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">C</span></i><span style="color: black;"> = $10,000<o:p></o:p></span></span></p>
<p class="MsoNormal" style="text-align: left;"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">R</span></i><span style="color: black;"> = 5% <o:p></o:p></span></span></p>
<p class="MsoNormal" style="text-align: left;"><span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;"><span style="color: black;">B</span></i><span style="color: black;"> = $10,000 - $2,500 = $7,500<o:p></o:p></span></span></p>
<p class="MsoNormal" style="text-align: left;"><span style="font-family: inherit;">Solving
<i>n</i>:</span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjELeJ73LOTz3xQDZJzo3s9NdRS-twjgqqBigvPuT1R-WpGvy7RxDDm6K1bW3MW9kOtr8r-H6nkNPaJnPRidcjRtc-SKxVGOfM8LN2f5lv4M9E2e3T2TSbfgCimoO5VVXxCh9f4csmh40/s460/Formula_4.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="76" data-original-width="460" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjELeJ73LOTz3xQDZJzo3s9NdRS-twjgqqBigvPuT1R-WpGvy7RxDDm6K1bW3MW9kOtr8r-H6nkNPaJnPRidcjRtc-SKxVGOfM8LN2f5lv4M9E2e3T2TSbfgCimoO5VVXxCh9f4csmh40/s320/Formula_4.PNG" width="320" /></a></div><br /><p class="MsoNormal"><br /></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;"><br /></span></span></p><p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">Alternatively,
we can also use another method to answer the questions, which is using
Tabulation, as what has been done in the previous article:<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="color: black;"><o:p><span style="font-family: inherit;"></span></o:p></span></p><div class="separator" style="clear: both; text-align: center;"><span style="color: black;"><span style="font-family: inherit;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIAJOp_wrA4q2FOt5_5lW5wx7uAqoALEmYK17vqfu8d350a5oPOATtkglhvtLNHmn2oEQTm_J92-MXEy9zZInt8u1IjSLE5joIaDvsmUVrNjeOWgFerxMO3fZH_VZaS-kZkMs8OzDAqrc/s739/Money+Mgmt_Method+2.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="510" data-original-width="739" height="221" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIAJOp_wrA4q2FOt5_5lW5wx7uAqoALEmYK17vqfu8d350a5oPOATtkglhvtLNHmn2oEQTm_J92-MXEy9zZInt8u1IjSLE5joIaDvsmUVrNjeOWgFerxMO3fZH_VZaS-kZkMs8OzDAqrc/w320-h221/Money+Mgmt_Method+2.PNG" width="320" /></a></span></span></div><span style="color: black;"><span style="font-family: inherit;"><br /></span></span><span style="font-family: inherit;">Using
this way, after inputting the formula in MS Excel accordingly, we just need to
“drag the row” to copy the formula until we reach the desired account balance.</span><p></p>
<p class="MsoNormal"><span style="color: black;"><span style="font-family: inherit;">From
the above table, the answer for Qtn 1 is highlighted in yellow, whereas the
answer for Qtn 2 is in green.<o:p></o:p></span></span></p>
<p class="MsoNormal"><span style="font-family: inherit;">For
reference, the following are the formula used for both methods:</span></p><p class="MsoNormal"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmER_H3bFn_Qyy9-sYopjDYa1clRAnf1MizrdO9XTMOwS6sGMg78J2wt_R3zd7uxLTyasd7Ql7cYILU0mbOxQJhr4kk_xFDCF5quFJqwh-LDeq7f4D5gw4Af5mIa3h3gZQPys2v2HqEW0/s932/Money+Mgmt_Method+2_Formula.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="747" data-original-width="932" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmER_H3bFn_Qyy9-sYopjDYa1clRAnf1MizrdO9XTMOwS6sGMg78J2wt_R3zd7uxLTyasd7Ql7cYILU0mbOxQJhr4kk_xFDCF5quFJqwh-LDeq7f4D5gw4Af5mIa3h3gZQPys2v2HqEW0/w400-h320/Money+Mgmt_Method+2_Formula.PNG" width="400" /></a></div><br /><span style="font-family: inherit;"><br /></span><p></p><p class="MsoNormal"><span face="Calibri, sans-serif" lang="EN">Go back to: Things To Consider in Setting
Money Management Rules – <a href="http://optionstradingbeginner.blogspot.sg/2015/02/things-to-consider-in-setting-money.html" target="_blank">Part 2: RISK TOLERANCE</a><o:p></o:p></span></p><p class="MsoNormal">To view the list of all the series on this topic, please refer to: <a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-position-sizing.html" target="_blank">Money Management / Position Sizing</a></p><div><strong><u><br /></u></strong></div><div>
<strong><u>Related Topics:</u></strong> </div><div> * <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a> </div><div> * <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a> </div><div> * <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a> </div><div> * <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a> </div><div> * <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a> </div><div> * <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a></div><div><br /></div>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-35074125812982527802015-02-05T17:48:00.001+08:002020-12-06T16:48:54.213+08:00Things to Consider in Setting Money Management Rules – Part 2: RISK TOLERANCEIn setting a suitable money management, you should also consider the maximum drawdown you are willing to accept, which depend on your risk tolerance. <br />
In this case, do take into account the reasonable percent return required to recover to breakeven when you experience a certain percent of losses (drawdown), as discussed in the previous <a href="http://optionstradingbeginner.blogspot.sg/2014/06/things-to-consider-in-setting-money.html" target="_blank">post</a>.<br />
Then, set money management rules based on your risk tolerance (expressed in terms of percentage of the total account/capital).<br />
<br />
Just a simple example:<br />
If you are willing to suffer from losses of maximum of 25% of your total capital, this means your risk tolerance is minus 25%. In this case, you should set money management rules and/or choose trading strategy that has a maximum drawdown statistics of 25% or less. <br />
<br />
Consider two options of the following money management rules:<br />
Option 1: Maximum of 2% risk (of the remaining account balance) in each trade<br />
Option 2: Maximum of 5% risk (of the remaining account balance) in each trade<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzsor6d1uXHhwACZvhG7_T7aJa9TkNGxoml5ILtdaoF_VVDBiua_JeuUxUMpPwjfd4uwf5zboxSB7TZF_7u2FVFjNL4mGSz342yBg1Jfyb0Go0Xa33AisRmh-eSGikkQiD-miE2w4APEE/s1600/MM_2percent.gif" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzsor6d1uXHhwACZvhG7_T7aJa9TkNGxoml5ILtdaoF_VVDBiua_JeuUxUMpPwjfd4uwf5zboxSB7TZF_7u2FVFjNL4mGSz342yBg1Jfyb0Go0Xa33AisRmh-eSGikkQiD-miE2w4APEE/s1600/MM_2percent.gif" width="261" /></a><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjrVQwvVfx6eh8FRjUJCFRHUSCxyWwyLp8ZjOfCB9aIDsEkwSoiqaWpMqoH7rYcK9CsArMmw8EOyP0J8P1oKhHLk95hJdLQXrAODL1DmjiTj4EzYv48-zbcBwGL0ipDYtTJPr-JgyEpFds/s1600/MM_5percent.gif" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjrVQwvVfx6eh8FRjUJCFRHUSCxyWwyLp8ZjOfCB9aIDsEkwSoiqaWpMqoH7rYcK9CsArMmw8EOyP0J8P1oKhHLk95hJdLQXrAODL1DmjiTj4EzYv48-zbcBwGL0ipDYtTJPr-JgyEpFds/s1600/MM_5percent.gif" width="265" /></a></div>
<br />
<br />
As can be seen from the above table, using Option 1 (max 2% risk for each trade), your account will drop to a level that is close to your risk tolerance of maximum 25% drawdown only after 14 consecutive losing trades.<br />
In contrast, using Option 2 (max 5% risk for each trade), your account will even exceed that level only after 6 losing trades in a row. <br />
<br />
Looking at another perspective, Option 1 will suffer 26.1% loss in the case of 15 consecutive losing trades, which would require 35.4% gain in order to be back to breakeven.<br />
On the other hand, with the same scenario of 15 successive losing trades, Option 2 suffers 53.7% drawdown and will need 115.8% gain, which is much harder to achieve, to be breakeven. Although losing 15 times in a row is quite an extreme case, in reality it is still possible to happen. <br />
<br />
Remember that although you might have implemented strict money management rules, losing streaks and drawdowns are inevitable.<br />
Hence, you should set a sound money management strategy that aims to avoid risk of ruin at all cost, can survive a period of losing streaks, and also still reasonable to rebound to at least break even.<br />
<br />
Continue to: Things to Consider in Setting Money Management Rules – Part 3: HOW LONG YOUR CAPITAL CAN LAST<br />
<br />
Go back to: Things To Consider in Setting Money Management Rules - <a href="http://optionstradingbeginner.blogspot.sg/2014/06/things-to-consider-in-setting-money.html" target="_blank">Part 1: DRAW DOWN</a><br />
<br />To view the list of all the series on this topic, please refer to:<br />
<a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-position-sizing.html" target="_blank">Money Management / Position Sizing</a><br />
<br /><strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-12593683819950388932014-06-17T14:55:00.003+08:002020-12-06T16:51:00.837+08:00Things to Consider in Setting Money Management Rules – Part 1: DRAW DOWNOne important part of money management/position sizing is the ability of a trader/investor to avoid large draw downs or limit the draw downs to a certain percentage of the trading capital/portfolio. <br />
If the traders/investors always take high risk in their trades, they are more likely to experience disastrous drawdown. Therefore, the way to avoid it is by limiting the size of what you are prepared to lose / risk in any single trade to a certain percentage of your total trading capital/portfolio (i.e. proper position sizing).<br />
<br />
A <strong>draw down</strong> is defined as a reduction in the account/portfolio from its highest point resulted from a losing trade or series of losing trades during a certain period.<br />
A draw down is measured in terms of a percentage between a recent peak to a recent trough of the account/portfolio. <br />
If all your trades were profitable, you will never experience a drawdown. The calculation of draw down would begin only with a losing trade, and continue so long as the account hits new lows.<br />
<br />
With regards to drawdown, it is important to understand that <strong>the percentage return that you need to make in order to get back to breakeven is bigger than the percentage of losses you experienced</strong>. <br />
So, if you lose 10%, you cannot gain back to breakeven by getting 10% return in the next trade, but it would be more than 10%. <br />
For example: <br />
Suppose your initial capital is $1000. If you lose 10% ($100), the remaining capital will be $900. If in the next trade you make 10%, your capital will only reach $990, still losing $10 (or 1% loss from the initial capital). In order to recover to breakeven, you will need to make $100/$900 = 11.1% in your next trade.<br />
<br />
The following table shows <strong>the percent return required to recover to breakeven when you experience a certain percent of losses (drawdown)</strong>.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLQnuOUxp02NaLuXB478IbUAgkQk7-b3ryqGukjnvLfRDeAblsyoRKMui-SHVxmn7mU-huqBxPDebo1rcDvm2lNq0Px3rbgVAYIzGL0zZUOAASh-F4KOD94RI3EuhFw-HDX00ZSEtX-IY/s1600/MM_Loss+vs+Gain+to+BE.gif" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLQnuOUxp02NaLuXB478IbUAgkQk7-b3ryqGukjnvLfRDeAblsyoRKMui-SHVxmn7mU-huqBxPDebo1rcDvm2lNq0Px3rbgVAYIzGL0zZUOAASh-F4KOD94RI3EuhFw-HDX00ZSEtX-IY/s1600/MM_Loss+vs+Gain+to+BE.gif" width="160" /></a></div>
<br />
From the table, we can see that <strong>as drawdown increases, the percent gain required to recover / get back to breakeven increases in a much faster rate</strong>.<br />
For instance, when you lose 20%, you would need to make 25% return on the remaining capital to get back to breakeven. However, if you lose 40%, you have to gain 66.7% to breakeven. <br />
Further, a 50% drawdown would require a 100% return, and drawdowns above 50% require huge returns in order to recover to breakeven. <br />
<br />
From here you can see that the more you lose, the more difficult for you to make it back to your original account size. When you risk too much and lose, your chances to recover your capital fully would be very slim. It is not only because you are merely left with much less money in your account, but also you have to deal with the negative psychological impacts of the drawdowns.<br />
<br />
Therefore, it is extremely important that you have good money management rules, so that when you experience losing streaks and suffer from drawdowns, you will still have enough money to stay in the game. <br />
With a proper money management, you should only risk a small percentage of your account in each trade, so that you can survive your losing streaks and also avoid a disastrous drawdown in your account. <br />
<br />
Continue to: Things To Consider in Setting Money Management Rules - <a href="http://optionstradingbeginner.blogspot.sg/2015/02/things-to-consider-in-setting-money.html" target="_blank">Part 2: RISK TOLERANCE</a><br />
<br />
Go back to: <a href="http://optionstradingbeginner.blogspot.sg/2014/04/the-importance-of-money-management.html" target="_blank">The Importance of Money Management / Position Sizing</a><br />
<br />
To view the list of all the series on this topic, please refer to:<br />
<a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-position-sizing.html" target="_blank">Money Management / Position Sizing</a><br />
<br /><strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-17509239314372982932014-04-15T14:37:00.001+08:002020-12-06T16:53:14.479+08:00The IMPORTANCE of Money Management / Position SizingThe main reason why money management / position sizing is extremely important is capital preservation ….. to avoid the risk of ruin from a losing streak. <br />
So long as you have the money / capital to trade, you would still have a chance to recover your losses. However, if your capital is gone, you would have no chance at all to recover, as you have no more money for trading.<br />
<br />
You may have a high probability trading system that gives you 70% probability of winning. But without sound money management system, you might still get wiped out of the game after unfortunate losing streaks. <br />
A 70% win in 100 trades does not necessarily mean you would win 7 out of every 10. You will not know which 70 out of the 100 trades will be the winners. It is possible that you lose the first 30 trades consecutively and then win the remaining 70, which still gives you a 70% winning system. However, when that happens, will you be still in the game if you lost 30 trades in a row?<br />
<br />
This is the reason why money management is very important. No matter how good your trading system is, you could still be facing a losing streak. Hence, you need to set a sound money management system, which will still allow you to stay in the game even if you go through a horrible losing streak.<br />
<br />
In view of the above, there are at least a few basic things that you should consider when setting Money Management rules:<br />
1) Draw downs.<br />
2) Considering your Risk Tolerance.<br />
3) How long your capital can last.<br />
<br />
In the next posts, we’ll discuss the above topics further.<br />
<br />
Continue to: <a href="http://optionstradingbeginner.blogspot.sg/2014/06/things-to-consider-in-setting-money.html" target="_blank">Things To Consider in Setting Money Management Rules - Part 1: DRAW DOWN</a>.<br />
<br />
Go back to: <a href="http://www.optionstradingbeginner.blogspot.sg/2014/02/basically-there-are-two-main-objectives.html" target="_blank">OBJECTIVES of Money Management or Position Sizing</a>.<br />
<br />To view the list of all the series on this topic, please refer to:<br />
<a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-position-sizing.html" target="_blank">Money Management / Position Sizing</a><br />
<br /><strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-57559895877879646432014-02-19T23:39:00.002+08:002020-12-06T16:54:16.067+08:00Money Management or Position Sizing – Part 2: OBJECTIVESBasically, there are <strong>two main objectives of Money Management or Position Sizing</strong>:<br />
<br />
<strong>1) Preserve Capital</strong> <br />
Preserving your capital should be the first and the most important objective of Money Management / Position Sizing for a trader.<br />
In order to be able to trade, you’ll need capital. As long as you have the money / capital to trade, you would still have a chance to make a recovery from your losses. However, if your capital is gone, you would have no chance at all to recover, as you have no more money for trading.<br />
<br />
In order to be successful in trading, it's not about making the big wins on every single trade, but rather, how to minimize the losses in order to live another day to trade.<br />
For example, you may have a very good month and make 200-300% on every trade. Each time, you are putting 70% - 80% of your total capital/account balance into each trade. However, it is possible that all your gains, or perhaps even your whole capital, get wiped out by just one losing trade. That is why proper money management is extremely important!<br />
<br />
No doubt, losses are always part of trading. However, if you are only risking a small percentage of your account in one trade, then that is the most you can lose on any one trade. <br />
Therefore, Money Management / Position Sizing can also be considered as “Risk Management”, because it’s basically also about managing your risk for every trade by limiting how much you put into each trade, so that you won’t get wiped out so easily just after a few trades.<br />
<br />
Why do we need that? Doesn’t putting a <strong>Stop Loss</strong> serve the same purpose of limiting our risk in a trade as well?<br />
Yes, putting a Stop Loss can protect your trade. Nevertheless, there is always a risk that a position may go bust even before your stop loss can be executed. <br />
For example: <br />
A stock can significantly gap down at the market opening due to sudden negative news (e.g. lower than expected earnings, fraud / lawsuit cases, etc.). When this happens, the price may go down way below the Stop Price.<br />
<br />
As Dr Alexander Elder suggested in his book, <a href="http://optionstradingbeginner.blogspot.com/2008/03/book-review-come-into-my-trading-room.html" target="_blank">Come Into My Trading Room</a>:<br />
<br />
<em>Technical analysis helps you decide where to place a stop, limiting your loss per share. </em><br />
<em>Money management rules help you protect your account as a whole. </em><br />
<em>The single most important rule is to limit your loss on any trade to a small fraction of your account.</em><br />
<br />
<strong>2) Grow Capital</strong> <br />
Other than just preserving your capital, Money Management / Position Sizing has another objective: to grow your capital at a steady pace.<br />
<br />
With Position Sizing, you can improve your gains during winning streaks, while you can limit your losses during losing streaks. <br />
How this can be done will be discussed further in the future articles.<br />
<br />
Basically, the Position Sizing seeks to balance between the two objectives: preserving vs. growing your capital.<br />
If you risk too little per trade, you win little, and hence it will take much longer time to grow your account. If you risk too much, it will put your account into danger. Ideally, it should be somewhere in between. <br />
<br />
Continue to: <a href="http://optionstradingbeginner.blogspot.sg/2014/04/the-importance-of-money-management.html" target="_blank">The IMPORTANCE of Money Management or Position Sizing</a>.<br />
<br />
Go back to: <a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-or-position-sizing.html" target="_blank">WHAT is Money Management or Position Sizing?</a><br />
<br />
To view the list of all the series on this topic, please refer to:<br />
<a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-position-sizing.html" target="_blank">Money Management / Position Sizing</a><br />
<br /><strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-91498747301679024862014-01-18T23:55:00.001+08:002020-12-06T16:54:55.760+08:00Money Management or Position Sizing – Part 1: WHAT IS IT?As frequently mentioned earlier, <strong>Money Management</strong> is one of are the most important aspects of a trading system, along with <strong>positive expectancy</strong> and <strong>self management (trading psychology)</strong>, which many professionals even believe that these aspects are the “holy grails” of trading. <br />
<br />
While Money Management is extremely crucial, it is important to note that having a trading system that gives you a <strong>positive expectancy</strong> should be in the top priority when you are developing a trading plan. Because if your trading system has a negative expectancy, no matter how well your money management strategy is, you’ll still lose money in the long term. <br />
<br />
This is like what Alexander Elder said in his book, <a href="http://optionstradingbeginner.blogspot.com/2008/03/book-review-come-into-my-trading-room.html" target="_blank">Come Into My Trading Room</a>:<br />
<br />
<em>A good trading system gives you an edge in the market.</em><br />
<em>To use a technical term, it provides a positive expectation over a long series of trials.</em><br />
<em>A good system ensures that winning is more likely than losing over a long series of trades.</em><br />
<em>If your system can do that, you need money management.</em><br />
<em><strong>But if you have no positive expectation, no amount of money management will save you from losing.</strong></em><br />
<br />
<strong><u>What is Money Management?</u></strong><br />
In his book “<a href="http://www.amazon.com/gp/product/007147871X?ie=UTF8&tag=optitradbegi-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=007147871X">Trade Your Way to Financial Freedom</a><img alt="" border="0" height="1" src="http://www.assoc-amazon.com/e/ir?t=optitradbegi-20&l=as2&o=1&a=007147871X" style="border: currentcolor; margin: 0px;" width="1" />”, Dr. Van K. Tharp define “<strong>Money Management</strong>” as <em>the part of your trading system that answer the question of “how much?” throughout the course of a trade. </em><br />
<em>How much essentially means how big a position you should have at any given time throughout the course of a trade</em>.<br />
Therefore, he refers to Money Management as “<strong>Position Sizing</strong>”. <br />
<br />
<iframe frameborder="0" marginheight="0" marginwidth="0" scrolling="no" src="http://rcm.amazon.com/e/cm?t=optitradbegi-20&o=1&p=8&l=as1&asins=007147871X&fc1=000000&IS2=1&lt1=_blank&lc1=0000FF&bc1=000000&bg1=FFFFFF&f=ifr" style="height: 240px; width: 120px;"></iframe><br />
<br />
The <strong>purpose</strong> of Position Sizing is <em>to limit the size of what you are prepared to lose / risk in any single trade to a percentage of your total trading capital</em>.<br />
<br />
Some people may also call this as “<strong>Bet Size</strong>”.<br />
Hence, Money Management, Position Sizing, and Bet Size are basically referring to the same thing, which is to answer “<em>how much</em>” in your trading system, as discussed in this post: <a href="http://optionstradingbeginner.blogspot.com/2007/08/trading-system-what-is-it-and-is-it.html" target="_blank">Trading System: What Is It and Is It Important?</a><br />
<br />
To be continued to: <a href="http://www.optionstradingbeginner.blogspot.sg/2014/02/basically-there-are-two-main-objectives.html" target="_blank">OBJECTIVES of Money Management or Position Sizing</a>.<br />
<br />
To view the list of all the series on this topic, please refer to:<br />
<a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-position-sizing.html" target="_blank">Money Management / Position Sizing</a><br />
<br /><strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com4tag:blogger.com,1999:blog-2092963398381163069.post-70415476327710486492014-01-18T23:34:00.003+08:002021-02-14T11:05:23.323+08:00Money Management / Position SizingMoney Management is a very important component in trading.<br />
In his book, <a href="http://optionstradingbeginner.blogspot.com/2008/03/book-review-come-into-my-trading-room.html" target="_blank">Come Into My Trading Room</a>, Alexander Elder emphasized the importance of Money Management to be successful in trading:<br />
<br />
<em>Every winner needs three essential components of trading: a sound individual psychology, a logical trading system and a good money management. </em><br />
<em></em><br />
<em>These essentials are three legs of a stool – remove one and the stool will fall together with the person who sits on it.</em><br />
<em></em><br />
<em>Losers try to build a stool with only one leg, or two at the most. They usually focus exclusively on trading systems.</em><br />
<em></em><br />
<em>Your trade must be based on clearly defined rules. </em><br />
<em>You have to analyze your feelings as you trade, to make sure that your decisions are intellectually sound. </em><br />
<em>You have to structure your money management so that no string of losses can kick you out of the game.</em><br />
<br />
Therefore, here I am trying to summarize and share with you what I learnt about this topic.<br />
<br />
The following is the list of articles (to be published) in this Money Management series: <br />
(Click the link below to read each post – The link will be up once the post has been published.)<br />
<br />
1) <a href="http://www.optionstradingbeginner.blogspot.sg/2014/01/money-management-or-position-sizing.html" target="_blank">WHAT is Money Management / Position Sizing? (Definition)</a><br />
2) <a href="http://www.optionstradingbeginner.blogspot.sg/2014/02/basically-there-are-two-main-objectives.html" target="_blank">OBJECTIVES of Money Management / Position Sizing</a><br />
3) <a href="http://optionstradingbeginner.blogspot.sg/2014/04/the-importance-of-money-management.html" target="_blank">The IMPORTANCE of Money Management / Position Sizing</a><br />
<br />
4) Things to Consider in Setting Money Management Rules:<br />
a) <a href="http://optionstradingbeginner.blogspot.sg/2014/06/things-to-consider-in-setting-money.html" target="_blank">Part 1: Draw Down</a><br />
b) <a href="http://optionstradingbeginner.blogspot.sg/2015/02/things-to-consider-in-setting-money.html" target="_blank">Part 2: Risk Tolerance</a><br />
c) <a href="https://optionstradingbeginner.blogspot.com/2020/12/things-to-consider-in-setting-money.html" target="_blank">Part 3: How Long Your Capital Can Last</a><br />
<br />
5) <a href="https://optionstradingbeginner.blogspot.com/2021/02/avoiding-risk-of-ruin-from-draw-down.html" rel="nofollow" target="_blank">Avoiding the Risk of Ruin from a Draw Down</a><br />
<br />
6) Example of RULES of Money Management / Position Sizing (By Dr Alexander Elder): <br />
a) Part 1 – Introduction<br />
b) Part 2- The 2% Rule<br />
c) Part 3- How The 2% Rule Works <br />
d) Part 4 - The 6% Rule<br />
e) Part 5 – How The 6% Rule Works <br />
f) Part 6 – Recalculation After Moving Your Stop Prices<br />
g) Part 7 - Recalculation At Every Beginning Of The Month<br />
h) Step By Step Of Money Management Rules: Summary<br />
<br />
7) How To Calculate POSITION SIZING:<br />
a) Part 1: Steps Of Calculation<br />
b) Part 2: Example #1<br />
c) Part 3: Example #2<br />
<br /><strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-53515777283562596162013-04-07T16:46:00.000+08:002013-04-07T16:46:45.186+08:00Effects of IMPLIED VOLATILITY (IV) on Option Greek VEGA – With Past DATA and CHARTS<div class="MsoNormal" style="margin: 0in 0in 0pt;">
<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">The following is the <b style="mso-bidi-font-weight: normal;">behavior</b> of <b style="mso-bidi-font-weight: normal;">Vega</b> in relation to <b style="mso-bidi-font-weight: normal;">Implied Volatility (IV)</b> changes:<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></span></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">Vega is higher when volatility increases, particularly for ITM and OTM options. <o:p></o:p></span></span></i></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">However, Vega is relatively stable / unchanged for ATM option.<o:p></o:p></span></span></i></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">We’ll use the same past actual data as shown in the previous post on the <u>behavior of Delta</u>, namely:<o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).<o:p></o:p></span></span></div>
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<br /></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">Here is the summary of Vega values for different IV:<o:p></o:p></span></span></div>
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<span style="font-family: Georgia, "Times New Roman", serif;"><span style="font-family: 'Calibri','sans-serif'; mso-no-proof: yes;"><v:shapetype coordsize="21600,21600" filled="f" id="_x0000_t75" o:preferrelative="t" o:spt="75" path="m@4@5l@4@11@9@11@9@5xe" stroked="f"><v:stroke joinstyle="miter"></v:stroke><v:formulas><v:f eqn="if lineDrawn pixelLineWidth 0"></v:f><v:f eqn="sum @0 1 0"></v:f><v:f eqn="sum 0 0 @1"></v:f><v:f eqn="prod @2 1 2"></v:f><v:f eqn="prod @3 21600 pixelWidth"></v:f><v:f eqn="prod @3 21600 pixelHeight"></v:f><v:f eqn="sum @0 0 1"></v:f><v:f eqn="prod @6 1 2"></v:f><v:f eqn="prod @7 21600 pixelWidth"></v:f><v:f eqn="sum @8 21600 0"></v:f><v:f eqn="prod @7 21600 pixelHeight"></v:f><v:f eqn="sum @10 21600 0"></v:f></v:formulas><v:path gradientshapeok="t" o:connecttype="rect" o:extrusionok="f"></v:path><o:lock aspectratio="t" v:ext="edit"></o:lock></v:shapetype></span><span style="font-family: 'Calibri','sans-serif';"><o:p></o:p></span></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiarWmxKjKH0jLcOUpkrUErTcg1F-PPC_J0VWITedYqxoMSVL0xKaZFZlWEyUW8vyhGhzokSXkqNMMG4DOGoAR6iGg5TxwXW9tmxjz5e1le6GYSsJTirn1FJ4AH5j6F50luYAPEuaMJYUM/s1600/OptionGreek_DifferIV_Vega.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: Georgia, "Times New Roman", serif;"><img border="0" mta="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiarWmxKjKH0jLcOUpkrUErTcg1F-PPC_J0VWITedYqxoMSVL0xKaZFZlWEyUW8vyhGhzokSXkqNMMG4DOGoAR6iGg5TxwXW9tmxjz5e1le6GYSsJTirn1FJ4AH5j6F50luYAPEuaMJYUM/s1600/OptionGreek_DifferIV_Vega.gif" /></span></a></div>
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<span style="font-family: 'Calibri','sans-serif'; mso-no-proof: yes;"><o:p><span style="font-family: Georgia, "Times New Roman", serif;"> </span></o:p></span><span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">From the table, we can see that for<b style="mso-bidi-font-weight: normal;"> ITM options</b> (e.g. option’s strike price $35 and $37.5) and<b style="mso-bidi-font-weight: normal;"> OTM options</b> (e.g. option’s strike price $55 and $52.5), Vega <b style="mso-bidi-font-weight: normal;">increases</b> as IV increases , i.e. as it moves from the left (IV = 25, the lowest IV in this example) to the right (IV = 85, the highest IV in this example).<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></span></div>
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<span style="font-family: 'Calibri','sans-serif'; font-size: 12pt;"><span style="font-family: Georgia, "Times New Roman", serif;">On the other hand, for <b style="mso-bidi-font-weight: normal;">near ATM options</b> (i.e. the option’s strike price $45.00, because the stock price is $44.78), Vega is relatively unchanged with the change in IV.<o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">Hence, these observations are in line with the statement above.<o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">Now, let’s study the behavior of Vega of different IV at various strike prices (as shown in the chart below).<o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif'; mso-no-proof: yes;"><o:p><span style="font-family: Georgia, "Times New Roman", serif;"></span></o:p></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7SZej6GF6wvO_eK_T1DJiYZSC0CQx4h1hhL2A279t730y98Z7iq7JEtlwSJrvZ8dnPe1xMM8wnvMm7gns2CyuzRaVSBsR5vMHDQuD0Fb847fKocyQBWghxh3pchOj_N-RwJ8GjKL-0Ik/s1600/OptionGreek_DifferIV_Vega_Chart.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: Georgia, "Times New Roman", serif;"><img border="0" height="245" mta="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7SZej6GF6wvO_eK_T1DJiYZSC0CQx4h1hhL2A279t730y98Z7iq7JEtlwSJrvZ8dnPe1xMM8wnvMm7gns2CyuzRaVSBsR5vMHDQuD0Fb847fKocyQBWghxh3pchOj_N-RwJ8GjKL-0Ik/s400/OptionGreek_DifferIV_Vega_Chart.gif" width="400" /></span></a></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">As can be seen in the chart: <o:p></o:p></span></span></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">For all the three options with different IV, Vega always behaves the same way, i.e. Vega of <b style="mso-bidi-font-weight: normal;">ATM</b> options is always <b style="mso-bidi-font-weight: normal;">higher</b>, and it <b style="mso-bidi-font-weight: normal;">gets lower</b> as it moves towards <b style="mso-bidi-font-weight: normal;">deep ITM and deep OTM</b> options.<o:p></o:p></span></span></i></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">However, the <b style="mso-bidi-font-weight: normal;">decrease in Vega</b> as the option moves from ATM towards <b style="mso-bidi-font-weight: normal;">deep ITM/OTM</b> will be <b style="mso-bidi-font-weight: normal;">greater</b> for options with <b style="mso-bidi-font-weight: normal;">lower IV</b> as compared to options with higher IV.<o:p></o:p></span></span></i></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">For <b style="mso-bidi-font-weight: normal;">deep ITM</b> and <b style="mso-bidi-font-weight: normal;">deep OTM</b> options, <b style="mso-bidi-font-weight: normal;">Vega</b> is very small (<b style="mso-bidi-font-weight: normal;">close to zero</b>) when <b style="mso-bidi-font-weight: normal;">IV </b>is<b style="mso-bidi-font-weight: normal;"> low</b>.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">To view the list of all the series of articles in this topic, please refer to: </span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;"><a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html" target="_blank">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS<o:p></o:p></a></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;"><strong><u>Other Learning Resources:</u></strong><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;"><strong><u>Related Topics:</u></strong><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><o:p></o:p></span></span></div>
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<span style="font-family: 'Calibri','sans-serif';"><span style="font-family: Georgia, "Times New Roman", serif;">* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a><o:p></o:p></span></span></div>
<span style="font-family: Georgia, "Times New Roman", serif;"></span>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-25633990126370057312013-03-29T00:07:00.000+08:002013-03-29T00:24:06.754+08:00Effects of IMPLIED VOLATILITY (IV) on Option Greek THETA – With Past DATA and CHARTS<div class="MsoNormal" style="margin: 0in 0in 0pt;">
<span style="font-family: inherit;">The following is the <b style="mso-bidi-font-weight: normal;">behavior</b> of <b style="mso-bidi-font-weight: normal;">Theta</b> in relation to <b style="mso-bidi-font-weight: normal;">Implied Volatility (IV)</b> changes:<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></div>
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<span style="font-family: inherit;"><br /></span></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">When Implied Volatility (IV) increases, Theta would be higher.<o:p></o:p></span></i></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">When IV decreases, Theta will be lower, especially when it is approaching expiration.<o:p></o:p></span></i></div>
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<span style="font-family: inherit;"><br /></span></div>
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<span style="font-family: inherit;">We’ll use the same past actual data as shown in the previous post on the <u><a href="http://www.optionstradingbeginner.blogspot.com/2012/05/behaviour-of-delta-in-relation-to.html" target="_blank">behavior of Delta</a></u>, namely:<o:p></o:p></span></div>
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<span style="font-family: inherit;">Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).<o:p></o:p></span></div>
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<span style="font-family: inherit;"><br /></span></div>
<div class="MsoNormal" style="margin: 0in 0in 0pt;">
<span style="font-family: inherit;">Here is the summary of Theta values for different IV:<o:p></o:p></span></div>
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<span style="font-family: inherit;"><span style="font-family: 'Calibri','sans-serif'; mso-no-proof: yes;"><v:shapetype coordsize="21600,21600" filled="f" id="_x0000_t75" o:preferrelative="t" o:spt="75" path="m@4@5l@4@11@9@11@9@5xe" stroked="f"><v:stroke joinstyle="miter"></v:stroke><v:formulas><v:f eqn="if lineDrawn pixelLineWidth 0"></v:f><v:f eqn="sum @0 1 0"></v:f><v:f eqn="sum 0 0 @1"></v:f><v:f eqn="prod @2 1 2"></v:f><v:f eqn="prod @3 21600 pixelWidth"></v:f><v:f eqn="prod @3 21600 pixelHeight"></v:f><v:f eqn="sum @0 0 1"></v:f><v:f eqn="prod @6 1 2"></v:f><v:f eqn="prod @7 21600 pixelWidth"></v:f><v:f eqn="sum @8 21600 0"></v:f><v:f eqn="prod @7 21600 pixelHeight"></v:f><v:f eqn="sum @10 21600 0"></v:f></v:formulas><v:path gradientshapeok="t" o:connecttype="rect" o:extrusionok="f"></v:path><o:lock aspectratio="t" v:ext="edit"></o:lock></v:shapetype></span><o:p></o:p></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgR2UrFk3KF5_mMjxbNkr5GTqfRgS5vdsyfmLNwi6Un5C2J2AYaPBntIFSIdgn23dmkLG3tiGb4IjMtBmqgv5ZVXOPKlUw-wp7QzlK4nhhRID0GiAZc8vsqvYuvu_ui_YrzZkcnlC_ON10/s1600/OptionGreek_DifferIV_Theta.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: inherit;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgR2UrFk3KF5_mMjxbNkr5GTqfRgS5vdsyfmLNwi6Un5C2J2AYaPBntIFSIdgn23dmkLG3tiGb4IjMtBmqgv5ZVXOPKlUw-wp7QzlK4nhhRID0GiAZc8vsqvYuvu_ui_YrzZkcnlC_ON10/s1600/OptionGreek_DifferIV_Theta.gif" usa="true" /></span></a></div>
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<span style="font-family: inherit;">From the table, we can observe that: <o:p></o:p></span></div>
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<span style="font-family: inherit;">Regardless of option’s strike prices (ATM/ITM/OTM), Theta always <b style="mso-bidi-font-weight: normal;">increases</b> as IV increases, i.e. as it moves from the left (IV = 25, the lowest IV in this example) to the right (IV = 85, the highest IV in this example).<o:p></o:p></span></div>
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<u><span style="font-family: inherit;">Note:<o:p></o:p></span></u></div>
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<span style="font-family: inherit;">Negative sign (which indicate the losing of time value) is ignored when doing the comparison.<o:p></o:p></span></div>
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<span style="font-family: inherit;">So, these observations verify the statements above.<o:p></o:p></span></div>
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<span style="font-family: inherit;">Now, let’s study the behavior of Theta of different IV at various strike prices (as shown in the chart below).<o:p></o:p></span></div>
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<span style="font-family: inherit;"><span style="font-family: 'Calibri','sans-serif'; mso-no-proof: yes;"></span><o:p></o:p></span></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6AmdJNz1j1A8MkdrDL1kCd_9dc3CxbZftMfSPvN9vMj7bhY16kMB3436CC2njKMaBmFk6Ja74mDK58uPSYiw8Jz2h8dKreCCuTcwvWSz4FqxV378vLaC3N1CAqVxJdlsLpJg08pQSaXc/s1600/OptionGreek_DifferIV_Theta_Chart.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: inherit;"><img border="0" height="245" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6AmdJNz1j1A8MkdrDL1kCd_9dc3CxbZftMfSPvN9vMj7bhY16kMB3436CC2njKMaBmFk6Ja74mDK58uPSYiw8Jz2h8dKreCCuTcwvWSz4FqxV378vLaC3N1CAqVxJdlsLpJg08pQSaXc/s400/OptionGreek_DifferIV_Theta_Chart.gif" usa="true" width="400" /></span></a></div>
<br /><span style="font-family: inherit;">As can be seen in the chart: <o:p></o:p></span></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">For all the three options with different IV, Theta always behaves the same way, i.e. Theta of <b style="mso-bidi-font-weight: normal;">ATM</b> options is always <b style="mso-bidi-font-weight: normal;">higher</b>, and it <b style="mso-bidi-font-weight: normal;">gets lower</b> as it moves towards <b style="mso-bidi-font-weight: normal;">deep ITM and deep OTM</b> options.<o:p></o:p></span></i></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">However, the <b style="mso-bidi-font-weight: normal;">decrease in Theta</b> as the option moves from ATM towards <b style="mso-bidi-font-weight: normal;">deep ITM/OTM</b> will be <b style="mso-bidi-font-weight: normal;">bigger</b> for options with <b style="mso-bidi-font-weight: normal;">higher IV</b> as compared to options with lower IV.<o:p></o:p></span></i></div>
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<span style="font-family: inherit;">This is understandable because options with higher IV will contain more time value than options with lower IV (Remember about <u><a href="http://optionstradingbeginner.blogspot.com/2007/05/option-pricing-how-is-option-priced_19.html" target="_blank">Options Pricing</a></u>).<o:p></o:p></span></div>
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<span style="font-family: inherit;">Since Theta is the decrease of time value due to the passage of time, Theta will naturally be higher for options with higher IV as it has more time value to lose, as compared to options with lower IV. <o:p></o:p></span></div>
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<span style="font-family: inherit;"><span lang="EN" style="font-family: 'Calibri','sans-serif'; mso-ansi-language: EN;">To view the list of all the series on </span>this topic<span lang="EN" style="font-family: 'Calibri','sans-serif'; mso-ansi-language: EN;">, please refer to:</span><b style="mso-bidi-font-weight: normal;"><u><o:p></o:p></u></b></span></div>
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<span lang="EN" style="font-family: 'Calibri','sans-serif'; mso-ansi-language: EN;"></span><a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html" target="_blank"><span style="font-family: inherit;">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS</span></a><span style="font-family: inherit;">.<span lang="EN" style="font-family: 'Calibri','sans-serif'; mso-ansi-language: EN;"></span></span></div>
<span style="font-family: inherit;"><o:p></o:p><br /></span>
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<span style="font-family: inherit;"><strong><u>Other Learning Resources:</u></strong><o:p></o:p></span></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html"><span style="font-family: inherit;">FREE Trading Educational Videos with Special Feature</span></a><o:p></o:p></div>
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<span style="font-family: inherit;">* </span><a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9"><span style="font-family: inherit;">FREE Trading Educational Videos from Trading Experts</span></a><o:p></o:p></div>
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<span style="font-family: inherit;"><strong><u>Related Topics:</u></strong><o:p></o:p></span></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html"><span style="font-family: inherit;">Understanding Implied Volatility (IV)</span></a><o:p></o:p></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html"><span style="font-family: inherit;">Understanding Option Greek</span></a><o:p></o:p></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html"><span style="font-family: inherit;">Understanding Option’s Time Value</span></a><o:p></o:p></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html"><span style="font-family: inherit;">Learning Candlestick Charts</span></a><o:p></o:p></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html"><span style="font-family: inherit;">Options Trading Basic – Part 1</span></a><o:p></o:p></div>
<span style="font-family: 'Calibri','sans-serif'; font-size: 12pt; mso-ansi-language: EN-US; mso-bidi-language: AR-SA; mso-fareast-font-family: 'Times New Roman'; mso-fareast-language: EN-US;"><span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html"><span style="font-family: inherit;">Options Trading Basic – Part 2</span></a></span>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-2953422019565590552013-03-19T09:00:00.000+08:002013-03-19T09:22:20.312+08:00Effects of IMPLIED VOLATILITY (IV) on Option Greek GAMMA – With Past DATA and CHARTS<div class="MsoNormal" style="margin: 0in 0in 0pt;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: inherit;">Impact of Implied Volatility (IV) on Gamma<o:p></o:p></span></b></div>
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<span style="font-family: inherit;">When the Implied Volatility increases, the Gamma of ATM options decreases, whereas the Gamma for deep ITM or OTM options increases.<o:p></o:p></span></div>
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<span style="font-family: inherit;">When the Implied Volatility is very low, the Gamma of ATM options is relatively high, while the Gamma for deep ITM / OTM options is relatively low (close to 0).<o:p></o:p></span></div>
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<span style="font-family: inherit;">This is because when the volatility is low, the time value portion of an option is low. However, time value of ATM option is still higher relative to ITM & OTM options, hence the Gamma of ATM option is higher as compared to ITM & OTM options. <o:p></o:p></span></div>
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<span style="font-family: inherit;">On the other hand, when IV is high, Gamma tends to be stable for ATM option as well as ITM and OTM options. This is because when volatility is high, the time value of deep ITM / OTM options are already quite substantial. As a result, the increase in the time value of deep ITM / OTM options as they go nearer the money will be less dramatic. Therefore, Gamma tends to be more stable across all strike prices in this case.<o:p></o:p></span></div>
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<span style="font-family: inherit;">We’ll use the same past actual data as shown in the previous post on the <u>behavior of Delta</u>, namely:<o:p></o:p></span></div>
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<span style="font-family: inherit;">Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).<o:p></o:p></span></div>
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<span style="font-family: inherit;">Here is the summary of Gamma values for different IV:</span><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFHkooYA1_u6pULkDALFUSH4txvNLU0nb82B4jSZYT3sgn6jUgidujli0AbUlZFYa2yQ8KScDYXRiyPmTUZkXKEefN9niXrRxCHFzO-cxMlE4wOtTJxudEsu6DzcaH-dULpLb-dnfwLhg/s1600/OptionGreek_DifferIV_Gamma.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: inherit;"><img border="0" psa="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFHkooYA1_u6pULkDALFUSH4txvNLU0nb82B4jSZYT3sgn6jUgidujli0AbUlZFYa2yQ8KScDYXRiyPmTUZkXKEefN9niXrRxCHFzO-cxMlE4wOtTJxudEsu6DzcaH-dULpLb-dnfwLhg/s1600/OptionGreek_DifferIV_Gamma.gif" /></span></a></div>
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<span style="font-family: inherit;">From the table, we can observe that for <b style="mso-bidi-font-weight: normal;">near ATM options</b> (i.e. the option’s strike price $45.00, because the stock price is $44.78), Gamma <b style="mso-bidi-font-weight: normal;">decreases</b> as IV increases, i.e. as it moves from the left (IV = 25, the lowest IV in this example) to the right (IV = 85, the highest IV in this example).<o:p></o:p></span></div>
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<span style="font-family: inherit;">Whereas <b style="mso-bidi-font-weight: normal;">for deep ITM options</b> (e.g. option’s strike price $35 and $37.5) and <b style="mso-bidi-font-weight: normal;">deep OTM options</b> (e.g. option’s strike price $55 and $52.5), Gamma <b style="mso-bidi-font-weight: normal;">increase</b> when IV increases.<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></div>
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<span style="font-family: inherit;">Hence, these observations show evidence to the first statement above.<o:p></o:p></span></div>
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<span style="font-family: inherit;">Now, let’s observe the behavior of Gamma of different IV at various strike prices (as shown in the chart below) to verify the next statements.<o:p></o:p></span></div>
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<o:p><span style="font-family: inherit;"></span></o:p></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEieHX1dEgtB7PGATAboHbHTHc8rs4-24SKqtkXItxZbyIU4tG7sOgl6siFLfd6FaOWdCWLIdx5ZRvE_n6t6HOQyUC4JS5Avru93FksrWRIMNzfs232QkzBOEe_bmmRjzjZb-OWgkG04VvA/s1600/OptionGreek_DifferIV_Gamma_Chart.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: inherit;"><img border="0" height="243" psa="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEieHX1dEgtB7PGATAboHbHTHc8rs4-24SKqtkXItxZbyIU4tG7sOgl6siFLfd6FaOWdCWLIdx5ZRvE_n6t6HOQyUC4JS5Avru93FksrWRIMNzfs232QkzBOEe_bmmRjzjZb-OWgkG04VvA/s400/OptionGreek_DifferIV_Gamma_Chart.gif" width="400" /></span></a></div>
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<span style="font-family: inherit;">As can be seen in the chart: <o:p></o:p></span></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">For all the three options with different IV, Gamma always behaves the same way, i.e. Gamma of <b style="mso-bidi-font-weight: normal;">ATM</b> options is always <b style="mso-bidi-font-weight: normal;">higher</b>, and it <b style="mso-bidi-font-weight: normal;">gets lower</b> as it moves towards <b style="mso-bidi-font-weight: normal;">deep ITM and deep OTM</b> options.<o:p></o:p></span></i></div>
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<span style="font-family: inherit;">That means:<o:p></o:p></span></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">Regardless of IV levels, the delta of <b style="mso-bidi-font-weight: normal;">ATM</b> option is most sensitive to changes in stock price (i.e. gamma is the highest for ATM option), as compared to ITM and OTM options.<o:p></o:p></span></i></div>
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<span style="font-family: inherit;">The chart also shows that <b style="mso-bidi-font-weight: normal;">when the IV is very low</b> (i.e. IV = 25 in this example), the Gamma of ATM options is relatively high, while the Gamma for deep ITM / OTM options is relatively low (close to 0).<o:p></o:p></span></div>
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<span style="font-family: inherit;"><b style="mso-bidi-font-weight: normal;">When IV is high</b> (i.e. IV = 85 in this example), Gamma values do not change so drastically (i.e. tend to be more stable) as the price moves across different level of option moneyness / strike prices.<o:p></o:p></span></div>
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<b style="mso-bidi-font-weight: normal;"><u><span style="font-family: inherit;">Conclusion:</span></u></b></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">Given the same IV, Gamma of <b style="mso-bidi-font-weight: normal;">ATM</b> option will always be <b style="mso-bidi-font-weight: normal;">higher</b> than that of deeper ITM and OTM options.<o:p></o:p></span></i></div>
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<span style="font-family: inherit;"><i style="mso-bidi-font-style: normal;">However, </i><b style="mso-bidi-font-weight: normal;">when IV is very low</b>, Gamma of ATM options is relatively high, while the Gamma for deep ITM / OTM options is relatively low (close to 0).<o:p></o:p></span></div>
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<span style="font-family: inherit;">And <b style="mso-bidi-font-weight: normal;">when IV is very high</b>, Gamma values do not change so drastically (i.e. tend to be more stable) as the price moves from deeper ITM/OTM towards ATM.<o:p></o:p></span></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">Given an <b style="mso-bidi-font-weight: normal;">ATM option</b>, the option with <b style="mso-bidi-font-weight: normal;">higher IV</b> will have <b style="mso-bidi-font-weight: normal;">lower Gamma</b>.<o:p></o:p></span></i></div>
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<i style="mso-bidi-font-style: normal;"><span style="font-family: inherit;">Given a <b style="mso-bidi-font-weight: normal;">deeper ITM or OTM option</b>, the option with <b style="mso-bidi-font-weight: normal;">higher IV</b> will have <b style="mso-bidi-font-weight: normal;">higher Gamma</b>.<o:p></o:p></span></i></div>
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<span style="font-family: inherit;"></span><span lang="EN" style="font-family: 'Calibri','sans-serif'; mso-ansi-language: EN;"><div class="MsoNormal" style="margin: 0in 0in 0pt;">
<span style="font-family: inherit;"></span></div>
</span><span style="font-family: inherit;">To view the list of all the series on this topic, please refer to:<o:p></o:p></span>
<br />
<span style="font-family: inherit;">“</span><a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html"><span style="color: blue; font-family: inherit;">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS.</span></a><span style="font-family: inherit;">”<o:p></o:p></span></div>
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<u><span lang="EN" style="font-family: inherit; font-size: 12pt; mso-ansi-language: EN; mso-bidi-language: AR-SA; mso-fareast-font-family: 'Times New Roman'; mso-fareast-language: EN-US;"><a 12pt="" alibri="" ar-sa="" en-us="" font-family:="" font-size:="" href="http://www.blogger.com/%3C/SPAN%3E%3CSPAN%20style=" imes="" mso-ansi-language:="" mso-bidi-language:="" mso-fareast-font-family:="" mso-fareast-language:="" new="" roman="" sans-serif=""></a></span></u></div>
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<span style="font-family: inherit;"><strong><u></u></strong><br /></span>
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<span style="font-family: inherit;"><strong><u>Other Learning Resources:</u></strong><o:p></o:p></span></div>
<div class="MsoNormal" style="margin: 0in 0in 0pt;">
<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html"><span style="font-family: inherit;">FREE Trading Educational Videos with Special Feature</span></a><o:p></o:p></div>
<div class="MsoNormal" style="margin: 0in 0in 0pt;">
<span style="font-family: inherit;">* </span><a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9"><span style="font-family: inherit;">FREE Trading Educational Videos from Trading Experts</span></a><o:p></o:p></div>
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<span style="font-family: inherit;"><br /></span></div>
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<span style="font-family: inherit;"><strong><u>Related Topics:</u></strong><o:p></o:p></span></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html"><span style="font-family: inherit;">Understanding Implied Volatility (IV)</span></a><o:p></o:p></div>
<div class="MsoNormal" style="margin: 0in 0in 0pt;">
<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html"><span style="font-family: inherit;">Understanding Option Greek</span></a><o:p></o:p></div>
<div class="MsoNormal" style="border-bottom: medium none; border-left: medium none; border-right: medium none; border-top: medium none; margin: 0in 0in 0pt;">
<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html"><span style="font-family: inherit;">Understanding Option’s Time Value</span></a><o:p></o:p></div>
<div class="MsoNormal" style="border-bottom: medium none; border-left: medium none; border-right: medium none; border-top: medium none; margin: 0in 0in 0pt;">
<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html"><span style="font-family: inherit;">Learning Candlestick Charts</span></a><o:p></o:p></div>
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<span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html"><span style="font-family: inherit;">Options Trading Basic – Part 1</span></a><o:p></o:p></div>
<div style="border-bottom: medium none; border-left: medium none; border-right: medium none; border-top: medium none;">
<span style="font-family: 'Calibri','sans-serif'; font-size: 12pt; mso-ansi-language: EN-US; mso-bidi-language: AR-SA; mso-fareast-font-family: 'Times New Roman'; mso-fareast-language: EN-US;"><span style="font-family: inherit;">* </span><a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html"><span style="font-family: inherit;">Options Trading Basic – Part 2</span></a></span></div>
OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-70125387206592098942012-05-26T00:20:00.000+08:002012-05-26T00:51:14.569+08:00Behaviour of DELTA in relation to IMPLIED VOLATILITY (IV) – With Past DATA and CHARTSPreviously, we’ve covered about the behavior of Option Greeks in relation to time remaining to expiration.<br />
From this post onwards, we’ll start to move on to discuss the behavior of Option Greeks in relation to Implied Volatility (IV).<br />
<br />
The following is the <strong>behavior</strong> of <strong>Delta</strong> in relation to <strong>Implied Volatility (IV)</strong> changes:<br />
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<em>When <strong>Implied Volatility (IV) increases</strong>, <strong>Delta</strong> of <strong>OTM</strong> option will <strong>increase</strong>, whereas the Delta of <strong>ITM</strong> option will <strong>decrease</strong>.</em><br />
<em>However, the Delta of <strong>ATM</strong> option will always <strong>remain</strong> at around <strong>0.5</strong>.</em><br />
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Now, let’s observe using the past real data.<br />
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The following is the Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78, expiration month Sep 2010 (10 days to expiration), and Implied Volatility (IV) is 25, 54.05, and 85, respectively. <br />
(The rows highlighted in yellow are ITM options, while those in white are OTM).<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDCRDmXgZG3EIOuWxCU0eLklkYbUn-HsBKp8QwTnUezB_fbMTZnsO6zakYBZ42-sWb7rlNeZkYTFehlPvWJpfVmM38FyfgVuWE1oxxPvfFvZxlmKqbAr2Uh0L_KEg58Ph85HamP5vahiY/s1600/OptionGreek_DiffIV_1.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="221px" qba="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDCRDmXgZG3EIOuWxCU0eLklkYbUn-HsBKp8QwTnUezB_fbMTZnsO6zakYBZ42-sWb7rlNeZkYTFehlPvWJpfVmM38FyfgVuWE1oxxPvfFvZxlmKqbAr2Uh0L_KEg58Ph85HamP5vahiY/s400/OptionGreek_DiffIV_1.gif" width="400px" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg75hu1rSzwt0cgim4ORyMqzRdfY8uFRS80fhxor5tB3GfxU3h6BAGU7LJS9NANmChUSVs_oHYVw_Y7UqXYeJwbxqIWFdm1WiEsrtQvUmyaf3udNiVzFH8_PuNl7CmREm2jm5ybKyiJ0e4/s1600/OptionGreek_DiffIV_2.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="198px" qba="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg75hu1rSzwt0cgim4ORyMqzRdfY8uFRS80fhxor5tB3GfxU3h6BAGU7LJS9NANmChUSVs_oHYVw_Y7UqXYeJwbxqIWFdm1WiEsrtQvUmyaf3udNiVzFH8_PuNl7CmREm2jm5ybKyiJ0e4/s400/OptionGreek_DiffIV_2.gif" width="400px" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtnp3KwRS_vB0XBoAsV_6D5sA6W9T3bh8QyejmGSnhSp7OAQ-QEvdGTY9goUQM-05Za35advieDS_m2K6z04h9LYufjnhOelhQKy6qnYtAbxbzq6UE4Sm3ufj5HqwjsdJVJ5vEunYqELs/s1600/OptionGreek_DiffIV_3.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="200px" qba="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtnp3KwRS_vB0XBoAsV_6D5sA6W9T3bh8QyejmGSnhSp7OAQ-QEvdGTY9goUQM-05Za35advieDS_m2K6z04h9LYufjnhOelhQKy6qnYtAbxbzq6UE4Sm3ufj5HqwjsdJVJ5vEunYqELs/s400/OptionGreek_DiffIV_3.gif" width="400px" /></a></div>
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For easier reading and comparison, I summarize the Delta for different IV as follow:<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKIsEPSuj6m6OgChac5dOVVjJMQd9cPFZktL2io3aHVAlnTkoMjdEtk98XpTZ7dk_YXRCGLFrEdP8lreL6XcCVmOwpSMCi1714UAXYlejkvjCJbmie3fJoAE0ei9A8LEffkRcUCutT3FQ/s1600/OptionGreek_DifferIV_Delta.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" qba="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKIsEPSuj6m6OgChac5dOVVjJMQd9cPFZktL2io3aHVAlnTkoMjdEtk98XpTZ7dk_YXRCGLFrEdP8lreL6XcCVmOwpSMCi1714UAXYlejkvjCJbmie3fJoAE0ei9A8LEffkRcUCutT3FQ/s1600/OptionGreek_DifferIV_Delta.gif" /></a></div>
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As can be seen from the table, for <strong>ITM</strong> options (highlighted in yellow), the <strong>Delta</strong> values <strong>decrease</strong> when <strong>IV increases</strong>, i.e. as it moves from the left (IV = 25, the lowest IV in this example) to the right (IV = 85, the highest IV in this example).<br />
In contrast, for <strong>OTM</strong> options (white rows in the table), the <strong>Delta</strong> values <strong>increase</strong> when IV increases.<br />
For near <strong>ATM</strong> options (i.e. the option’s strike price $45.00, because the stock price is $44.78), the <strong>Delta</strong> is about the <strong>same</strong>, i.e. close to 0.5, across all IV levels. <br />
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Subsequently, we can look from different point of view, i.e. by comparing Delta at various strike prices at different IV level, as shown in the chart below.<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIrV3tImFyTq7YeT7a4A9MLzWRfgbpaE75EKKTkyGgmYFHucSlKVXH2u88LX_ECWHbCAGn8cuqhfOD1NRb5B-eA1yD42-HkcKYEQd4kWerQcYlGqARLFXRnG50AmDn9-D3r7dW9dA0Ml8/s1600/OptionGreek_DifferIV_Delta_Chart.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="245px" qba="true" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIrV3tImFyTq7YeT7a4A9MLzWRfgbpaE75EKKTkyGgmYFHucSlKVXH2u88LX_ECWHbCAGn8cuqhfOD1NRb5B-eA1yD42-HkcKYEQd4kWerQcYlGqARLFXRnG50AmDn9-D3r7dW9dA0Ml8/s400/OptionGreek_DifferIV_Delta_Chart.gif" width="400px" /></a></div>
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From the chart, we can see that:<br />
<br />
<em>The effect of stock price changes on the option price (i.e. Delta) is more “extreme“ for <strong>ITM</strong> and <strong>OTM</strong> options with <strong>lower IV</strong>, as compared to those with higher IV.</em><br />
<em><strong>Lower IV</strong> will push the Deltas of <strong>ITM Calls closer to 1 (-1 for Puts)</strong> and the <strong>OTM</strong> option’s Delta <strong>closer to 0</strong>. </em><br />
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<em>In contrast, for <strong>ATM</strong> options, the Delta is relatively <strong>unaffected</strong> to changes in IV level, i.e. all will have Deltas close to 0.5.</em> <br />
<br />
<br />
To view the list of all the series on the this topic, please refer to:<br />
“<a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS.</a>”<br />
<br />
<strong><u>Other Learning Resources:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />
* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br />
<br />
<strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-16185389381547997452012-02-25T10:45:00.008+08:002012-02-25T11:07:50.068+08:00Behaviour of VEGA in relation to TIME REMAINING TO EXPIRATION – With Past DATA and CHARTSThe following is the <strong>behavior</strong> of <strong>Vega</strong> in relation to <strong>Time to Expiration</strong>:<br /><br />Assuming all other things unchanged, <strong>Vega decreases as the option gets nearer to expiration</strong>.<br /><br />We’ll use the same past actual data as shown in the previous post on the <a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-delta-in-relation-to-time.html">behavior of Delta</a>, namely:<br />Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).<br /><br />The summary of Vega values for different Time to Expiration:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigRvIIiw51pqs22FFzLhHruQT8-zBgS0g9kMfiQ4wBAq5G5oKg_SoeK0Dje5CgwAMfjgqyzD8p05wXl142P9kpCVJRSg2xMKiySNar2v5ilEZiw75Y14bkfJIrEoeAvoFfaO0gT1U11GE/s1600/OptionGreek_DiffMonths_Vega.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 271px; FLOAT: left; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5712900786985534290" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigRvIIiw51pqs22FFzLhHruQT8-zBgS0g9kMfiQ4wBAq5G5oKg_SoeK0Dje5CgwAMfjgqyzD8p05wXl142P9kpCVJRSg2xMKiySNar2v5ilEZiw75Y14bkfJIrEoeAvoFfaO0gT1U11GE/s400/OptionGreek_DiffMonths_Vega.gif" /></a><br />As can be seen from the table, <strong>for all level of moneyness (ITM, ATM, OTM)</strong>, Vega values are always <strong>lower </strong>for the options with expiration month “Sep-10” (nearer to expiration), followed by “Oct-10”, and then “Dec-10” (further to expiration).<br />This proves the statement above.<br /><br />Now, let’s move on to compare Vega of different time to expiration at various strike prices.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1r9A9Mva31fScyrjFWoUAYI0R8soMvTHq820YyouBcD266xWBzmb1YchGuHvRUKevCIk9I0ORmqYWJEuiMZrSQebSqHmdIuExgUZwXOE_GW4Q9SD4pavWfjIlXy0R50qVrhsAxDfxTv4/s1600/OptionGreek_DiffMonths_Vega+Chart.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 471px; FLOAT: left; HEIGHT: 284px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5712901012695221810" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1r9A9Mva31fScyrjFWoUAYI0R8soMvTHq820YyouBcD266xWBzmb1YchGuHvRUKevCIk9I0ORmqYWJEuiMZrSQebSqHmdIuExgUZwXOE_GW4Q9SD4pavWfjIlXy0R50qVrhsAxDfxTv4/s400/OptionGreek_DiffMonths_Vega+Chart.gif" /></a><br /><br />As can be seen in the chart:<br /><br /><em>For all the three options with different time to expiration, Vega always behaves the same way, i.e. Vega of <strong>ATM </strong>options is always <strong>higher</strong> than <strong>deeper ITM and OTM</strong> options.<br /><br />Comparing the Vega values between deeper ITM and OTM options given the same time to expiration, <strong>OTM option</strong> seem to have <strong>higher</strong> Vega than ITM option.<br /></em><br />This makes sense because ATM options have the highest time value component, and changes in Implied Volatility (IV) would only affect the time value portion of an option’s price.Comparing between ITM & OTM options, volatility changes would have greater effect for OTM options than for ITM options. This because OTM options comprise merely of time value, while ITM options comprise of intrinsic value plus time value. The deeper the ITM options, the smaller the portion of time value the ITM option would have.<br /><br />To view the list of all the series on the this topic, please refer to:<br />“<a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS.</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-47549959806215295092011-11-07T11:47:00.006+08:002011-11-07T12:20:58.114+08:00Behaviour of THETA in relation to TIME REMAINING TO EXPIRATION – With Past DATA and CHARTSThe following is the <strong>behavior</strong> of <strong>Theta</strong> in relation to <strong>Time to Expiration</strong>:<br /><br /><em>For <strong>ATM option</strong>, Theta increases as an option gets closer to the expiration date.<br />On the other hand, for <strong>ITM & OTM options</strong>, Theta decreases as an option is approaching expiration.<br />The above effects are particularly observed in the last few weeks (about 30 days) before expiration.</em><br /><br />Using the same past actual data as shown in the previous post on the <a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-delta-in-relation-to-time.html">behavior of Delta</a>, namely:<br />Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).<br /><br />The following is the summary of Theta values for different Time to Expiration:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiK_FJ7CuoFbsQ4QlhbmIE98Y2b9w-C8orz0M2M3jZsF2fKzaNNM3kDx2uT-webAmWAbBq3ZTho_whhJVmaXwf3aOaTenEwi4BMRqmqBmQAtpNeNJ9OWqt91WpWd8Fh2jkxn6eewYTpRuQ/s1600/OptionGreek_DiffMonths_Theta.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 271px; FLOAT: left; HEIGHT: 240px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5672097211821081298" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiK_FJ7CuoFbsQ4QlhbmIE98Y2b9w-C8orz0M2M3jZsF2fKzaNNM3kDx2uT-webAmWAbBq3ZTho_whhJVmaXwf3aOaTenEwi4BMRqmqBmQAtpNeNJ9OWqt91WpWd8Fh2jkxn6eewYTpRuQ/s400/OptionGreek_DiffMonths_Theta.gif" /></a><br /><br />For easier analysis, we can plot the Theta values of different Degree of Moneyness across various Time to Expiration, as follows:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxFMAIg3nnMJSHbvW3EgTsd_RXD_4clMSgQV_bw5Lnhgn0Tv3JYfLfFk3oi4BSy4q6pCb1Kgl7nHnRn5J6BMmeey5esza711mj4FgS-9ycGpDOes2mEPuVAqaHoeXSmwEvM6pLAP97MyA/s1600/OptionGreek_DiffMonths_Theta+Chart_Moneyness.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 474px; FLOAT: left; HEIGHT: 295px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5672098149231717634" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxFMAIg3nnMJSHbvW3EgTsd_RXD_4clMSgQV_bw5Lnhgn0Tv3JYfLfFk3oi4BSy4q6pCb1Kgl7nHnRn5J6BMmeey5esza711mj4FgS-9ycGpDOes2mEPuVAqaHoeXSmwEvM6pLAP97MyA/s400/OptionGreek_DiffMonths_Theta+Chart_Moneyness.gif" /></a><br /><br /><br />As can be seen from the table and the chart above:<br /><strong>For (near) ATM options</strong> (i.e. strike price $45.00, because the stock price is $44.78), Theta (in absolute value) is the <strong>higher</strong> for the options with expiration month “Sep-10” (nearer to expiration), as compared to “Oct-10” and “Dec-10”.<br />In other words, Theta (in absolute value) increases as time to expiration gets nearer.<br /><br />Whereas <strong>for both deep ITM</strong> (strike price $35.00 & $37.50) <strong>and deep OTM options</strong> (strike price $52.50 & $55.00), Theta (in absolute value) is the <strong>lower</strong> for the options with expiration month “Sep-10” (nearer to expiration), as compared to “Oct-10” and “Dec-10”.<br />In other words, Theta (in absolute value) decreases as time to expiration gets nearer.<br /><br /><u>Note:</u><br />For Theta, we’re always comparing Theta here (whether it’s high or low) in terms of the absolute value, because the negative sign only represents the decaying effect.<br /><br />Likewise, we’ll also compare Theta of different time to expiration at various strike prices, as shown in the chart below.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEihxCTEB5Xt2ddp66A8QxcAbzOnGOBqkIOTdceRXSs9aJ1p_-Wnrg9dOY3uoSJmb-qRLc9UlHlbxCqal2OasEJwwHhib1aoFg2QYtfsDKBqklAfn7ti5QqHCHhLq3tKYuH9BWeBvbFgFKs/s1600/OptionGreek_DiffMonths_Theta+Chart.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 474px; FLOAT: left; HEIGHT: 286px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5672097725162065538" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEihxCTEB5Xt2ddp66A8QxcAbzOnGOBqkIOTdceRXSs9aJ1p_-Wnrg9dOY3uoSJmb-qRLc9UlHlbxCqal2OasEJwwHhib1aoFg2QYtfsDKBqklAfn7ti5QqHCHhLq3tKYuH9BWeBvbFgFKs/s400/OptionGreek_DiffMonths_Theta+Chart.gif" /></a><br /><br />As can be seen in the chart:<br /><em>For all the three options with different time to expiration, Theta always behaves the same way, i.e. given the same time to expiration, Theta of <strong>ATM</strong> options is <strong>higher</strong>, and it <strong>gets lower</strong> as it moves towards <strong>deep ITM and deep OTM </strong>options.</em><br /><br />That means:<br /><em>Given the same time to expiration, ATM options will always decay faster as time goes by, as compared to deeper ITM and OTM options would.</em><br /><br />However, the blue line (i.e. options with expiration month “Sep-10”) is much steeper than the red line (i.e. options with expiration month “Oct-10”) and green line (i.e. options with expiration month “Dec-10”).<br />This means:<br /><br /><em>Theta values for options with <strong>nearer</strong> time to expiration <strong>differ more significantly</strong> along various strike prices, as compared to those with further time to expiration.<br />The further the time to expiration is, the smaller the difference in the Theta values across different strike prices will be.</em><br /><br /><u>Conclusion:</u><br /><em>Given the same time to expiration, <strong>ATM</strong> options will always decay <strong>faster</strong> as time goes by (i.e. have higher Theta) than the deeper ITM and OTM options would.<br /><br />Given an <strong>ATM</strong> option, the option with <strong>nearer</strong> time to expiration will have the <strong>highest</strong> Theta (will decay the fastest), as compared to that with longer time to expiration.<br /><br />Given a <strong>deeper ITM / OTM</strong> option, the option with <strong>nearer</strong> time to expiration will have the <strong>lowest</strong> Theta (will decay the slowest), as compared to that with longer time to expiration.</em><br /><br /><br />To view the list of all the series on the this topic, please refer to:<br />“<a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS.</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-66475971969404334902011-10-22T17:55:00.005+08:002011-10-22T18:10:06.879+08:00Behaviour of GAMMA in relation to TIME REMAINING TO EXPIRATION – With Past DATA and CHARTSAs discussed previously in the earlier post, here is the <strong>behavior</strong> of <strong>Gamma</strong> in relation to<br /><strong>Time to Expiration</strong>:<br /><br />Assume all other factors unchanged:<br /><strong>For ATM options</strong>, Gamma increases (is higher) as time to expiration is nearing.<br />In contrast, <strong>for both deep ITM and deep OTM options</strong>, Gamma normally decreases (is lower) as time to expiration is nearing.<br /><br />We will use the same past actual data as shown in the previous post on the behavior of Delta, namely:<br />Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).<br /><br />Similarly, here is the summary of Gamma values for different Time to Expiration:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzlg2IDRLsWBSErmXrV8VW4nMlGOMalmR6BRn3GR77lesDqj2fDrlpdl3yiDH6lur13nL7jK-jIt59beoiAp0Lphm5T7xp1pTDqshNSIgezLaRqWldbumUeelAzm2M_DgWjjLO-Az0SxM/s1600/OptionGreek_DiffMonths_Gamma.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 270px; FLOAT: left; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5666253816939277378" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzlg2IDRLsWBSErmXrV8VW4nMlGOMalmR6BRn3GR77lesDqj2fDrlpdl3yiDH6lur13nL7jK-jIt59beoiAp0Lphm5T7xp1pTDqshNSIgezLaRqWldbumUeelAzm2M_DgWjjLO-Az0SxM/s400/OptionGreek_DiffMonths_Gamma.gif" /></a><br /><br />As can be seen from the table, for both <strong>deep ITM</strong> (strike price $35.00 & $37.50) and <strong>deep OTM</strong> options (strike price $52.50 & $55.00), the Gamma values are the <strong>lowest</strong> for the options with expiration month “Sep-10” (nearer to expiration), followed by “Oct-10”, and then “Dec-10” (further to expiration).<br /><br />On the other hand, for <strong>near ATM options</strong> (i.e. strike price $45.00, because the stock price is $44.78), the Gammas are the <strong>highest</strong> for the options with expiration month “Sep-10” (nearer to expiration), followed by “Oct-10”, and then “Dec-10” (further to expiration).<br /><br />These prove the statement above.<br /><br />Now, let’s compare Gamma of different time to expiration at various strike prices, as shown in the chart below.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2vr8zZBLBD4vXPI3xsb3V87Blu91_O4aOcVgXxg554TnCmX2rdVFclTPqcXZ6hII3ypORFPik29Yi0sULPCNAq9j1fBpY7GgrFEcqH_UoQEpvHt2qyhY8y2zcTFPlmdTLTF5Nh90k8F8/s1600/OptionGreek_DiffMonths_Gamma+Chart.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 474px; FLOAT: left; HEIGHT: 277px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5666254146063617122" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2vr8zZBLBD4vXPI3xsb3V87Blu91_O4aOcVgXxg554TnCmX2rdVFclTPqcXZ6hII3ypORFPik29Yi0sULPCNAq9j1fBpY7GgrFEcqH_UoQEpvHt2qyhY8y2zcTFPlmdTLTF5Nh90k8F8/s400/OptionGreek_DiffMonths_Gamma+Chart.gif" /></a><br /><br />As can be seen in the chart:<br /><br />For all the three options with different time to expiration, Gamma always behaves the same way, i.e. Gamma of <strong>ATM</strong> options is always <strong>higher</strong>, and it <strong>gets lower</strong> as it moves towards <strong>deep ITM and deep OTM</strong> options.<br /><br />That means:<br />Given the same time to expiration, the Delta of ATM options changes the most when the stock price moves up or down, as compared to deeper ITM and OTM options.<br /><br />However, the blue line (i.e. options with expiration month “Sep-10”) is much steeper than the red line (i.e. options with expiration month “Oct-10”) and green line (i.e. options with expiration month “Dec-10”).<br />This shows that:<br /><br />Gamma values for options with <strong>nearer</strong> time to expiration <strong>differ more significantly</strong> along various strike prices, as compared to those with further time to expiration.<br />The further the time to expiration is, the smaller the difference in the Gamma values across different strike prices will be.<br /><br /><strong><u>Conclusion:</u></strong><br />Given the same time to expiration, Gamma of <strong>ATM</strong> option will always be <strong>higher</strong> than Gamma of deeper ITM and OTM options.<br /><br />Given an <strong>ATM option</strong>, the option with <strong>nearer time to expiration</strong> will have the <strong>highest</strong> Gamma, as compared to the option with longer time to expiration.<br /><br />Given a <strong>deeper ITM or OTM option</strong>, the option with <strong>nearer time to expiration</strong> will have the <strong>lowest</strong> Gamma, as compared to the option with longer time to expiration.<br /><br />To view the list of all the series on the this topic, please refer to:<br />“<a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS.</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-40019505585201906542011-09-24T12:11:00.006+08:002011-09-24T12:38:56.903+08:00Behaviour of DELTA in relation to TIME REMAINING TO EXPIRATION – With Past DATA and CHARTSThe following is the <strong>behavior </strong>of <strong>Delta</strong> in relation to <strong>Time to Expiration</strong>:<br /><br />Assume all other factors unchanged:<br />As the <strong>time to expiration is nearing</strong>, the <strong>Delta of ITM options increases</strong> (i.e. ITM option’s Delta gets closer to 1 for Calls or to -1 for Puts) and the <strong>Delta of OTM options decreases</strong> (i.e. OTM option’s Delta gets closer to 0).<br /><br />Now, let’s observe using the past real data.<br />The following is the Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).<br />(The rows highlighted in yellow are ITM options, while those in white are OTM).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixJCWYGaMQB6FiqfC5ZPxpF9reWMH5UPLlul2PNSGDd6_bkeWAfdomkf7wHbnbUWW_hNrZunDQG_SntPcMXEx83PpNNkeBMZMFA9XrIQjbtvsCHh3gAY6FhnGyg74P_nBAcopAdYht4PU/s1600/OptionGreek_DiffMonths.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 467px; FLOAT: left; HEIGHT: 425px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5655779516180743666" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixJCWYGaMQB6FiqfC5ZPxpF9reWMH5UPLlul2PNSGDd6_bkeWAfdomkf7wHbnbUWW_hNrZunDQG_SntPcMXEx83PpNNkeBMZMFA9XrIQjbtvsCHh3gAY6FhnGyg74P_nBAcopAdYht4PU/s400/OptionGreek_DiffMonths.gif" /></a><br /><br />For easier reading and comparison, I summarize the Delta for different time to expiration as follow:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8NnY5cbBWjx0HeVEo5iqk3GpyxTgXreMl-4V2lSC_vuTb9J9vikO7Cd_vRqiH3ViI11UkjifdT2AL3jBKHTnkGxCGpB-7iBV3i8GfISz2CKgeZUM9lT3POnT1Z6DSodOXt16prwAQjTY/s1600/OptionGreek_DiffMonths_Delta.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 269px; FLOAT: left; HEIGHT: 241px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5655779862964631346" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8NnY5cbBWjx0HeVEo5iqk3GpyxTgXreMl-4V2lSC_vuTb9J9vikO7Cd_vRqiH3ViI11UkjifdT2AL3jBKHTnkGxCGpB-7iBV3i8GfISz2CKgeZUM9lT3POnT1Z6DSodOXt16prwAQjTY/s400/OptionGreek_DiffMonths_Delta.gif" /></a><br /><br />As can be seen from the table, <strong>for ITM options</strong> (highlighted in yellow), the Deltas are the <strong>highest</strong> for the expiration month “Sep-10” (nearer to expiration), followed by “Oct-10”, and then “Dec-10” (further to expiration).<br /><br />On the other hand, <strong>for OTM options</strong>, the Deltas are the <strong>lowest</strong> for the expiration month “Sep-10” (nearer to expiration), followed by “Oct-10”, and then “Dec-10” (further to expiration).<br /><br />For <strong>near ATM options</strong> (i.e. the option’s strike price $45.00, because the stock price is $44.78), the Delta is <strong>about the same, i.e. close to 0.5</strong>.<br /><br />These observations are in line with the statement above.<br /><br />In addition, we can also look from different point of view, i.e. by comparing Delta at various strike prices at different time to expiration, as shown in the chart below.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjalJ7Fe75D0HAMrarbkUpFXBjwnI-FOknnPplge3Tt-K9CKIOSSCjZsNhyphenhypheneWMoPC6d0JvE0LslOEZUC-CSGe2Bc3kNis_0vdpVcpb8SuG2Z1L6I8s2zQac4p2vshwmHdamvph7OFST8fQ/s1600/OptionGreek_DiffMonths_Delta+Chart.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 474px; FLOAT: left; HEIGHT: 294px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5655780231332242946" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjalJ7Fe75D0HAMrarbkUpFXBjwnI-FOknnPplge3Tt-K9CKIOSSCjZsNhyphenhypheneWMoPC6d0JvE0LslOEZUC-CSGe2Bc3kNis_0vdpVcpb8SuG2Z1L6I8s2zQac4p2vshwmHdamvph7OFST8fQ/s400/OptionGreek_DiffMonths_Delta+Chart.gif" /></a><br /><br />From the chart, we can see that:<br /><br />The effect of stock price changes on the option price (i.e. Delta) are more “extreme“ <strong>for ITM and OTM options</strong> with <strong>nearer</strong> time to expiration, as compared to those with further time to expiration.<br />Nearer time to expiration will push the Deltas of <strong>ITM Calls closer to 1 (-1 for Puts)</strong> and the <strong>OTM option’s Delta closer to 0</strong>.<br /><br />In contrast, for ATM options, the Delta is relatively unaffected to changes in time to expiration, i.e. all will have Deltas close to 0.5.<br /><br /><u><strong>Implication</strong></u><br />So, what’s the implication?<br />We can use this knowledge to help us consider and choose which options to use for trading, given the trading opportunities, expectation of whether the price movement is big or small, expected time frame, and options strategies.<br /><br />For instance:<br />If you’re playing a swing trading and expect a stock’s price will change moderately within a short period, and you want to buy a straight Long Call to take advantage of this opportunity. In this case, you could consider using ITM options from a nearer time to expiration, as this option has higher Delta. Hence, when the stock price indeed increases as expected, you can gain more (in terms of dollar) from the increase in the option’s price.<br /><br />However, given the scenario, suppose due to capital constraint, you would like to use OTM options, then choosing OTM options from a longer time to expiration should be better to take advantage from the stock price movement (in terms of dollar), as this option has higher Delta.<br />(Note: This is just a simple example about how to make use of the knowledge on Delta behavior in your trading. Actually, using OTM options in such case would have lower chance to be profitable, as an OTM option would require a very big increase in the stock price for the option to be profitable.)<br /><br /><u><strong>The bottom line:</strong></u><br />Whatever strategy you use, do consider the behaviors of the Option Greeks to help you choose which options to use (ITM, ATM, or OTM) to enhance the probability to make money.<br /><br />Next, we’ll discuss about the behavior of the rest of the Options Greek.<br /><br />To view the list of all the series on the this topic, please refer to:<br />“<a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-option-greeks-in-relation.html">Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS.</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-59681596051667942242011-09-23T13:36:00.006+08:002013-04-07T16:50:12.800+08:00Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTSThe past articles in this blog have discussed many times about the effect of time remaining to expiration and IV on Options Greeks.<br />
In fact, not only this blog, many other websites have done the same too.<br />
Nevertheless, generally these topics are only discussed qualitatively, as it is quite tedious and time consuming to show these using real data.<br />
<br />
While there is an adage “A picture speaks a thousand words”, I am trying to show how Options Greeks behave in relation to the changes in time remaining to expiration or Implied Volatility (IV) by using the past real data and showing the relevant charts.<br />
<br />
The following is the list of articles in this series:<br />
<br />
<strong><u>Behaviour of Option Greeks in relation to TIME REMAINING TO EXPIRATION:</u></strong><br />
1. <a href="http://optionstradingbeginner.blogspot.com/2011/09/behaviour-of-delta-in-relation-to-time.html">Delta</a><br />
2. <a href="http://optionstradingbeginner.blogspot.com/2011/10/behaviour-of-gamma-in-relation-to-time.html">Gamma</a><br />
3. <a href="http://optionstradingbeginner.blogspot.com/2011/11/behaviour-of-theta-in-relation-to-time.html">Theta</a><br />
4. <a href="http://optionstradingbeginner.blogspot.com/2012/02/behaviour-of-vega-in-relation-to-time.html">Vega</a><br />
<br />
<strong><u>Behaviour of Option Greeks in relation to IMPLIED VOLATILITY:</u></strong><br />
1. <a href="http://www.optionstradingbeginner.blogspot.com/2012/05/behaviour-of-delta-in-relation-to.html" target="_blank">Delta</a><br />
2. <a href="http://www.optionstradingbeginner.blogspot.com/2013/03/effects-of-implied-volatility-iv-on.html" target="_blank">Gamma</a><br />
3. <a href="http://optionstradingbeginner.blogspot.com/2013/03/effects-of-implied-volatility-iv-on_29.html" target="_blank">Theta</a><br />
4. <a href="http://www.optionstradingbeginner.blogspot.sg/2013/04/effects-of-implied-volatility-iv-on.html" target="_blank">Vega</a><br />
<br />
By knowing better how Options Greeks behave in relation to the change in time remaining to expiration or Implied Volatility (IV), I hope this info can help you in your trading to enhance the probability to make money using whatever strategies that suit you.<br />
<br />
We'll start with the first article soon.<br />
<br />
<strong><u>Other Learning Resources:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />
* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br />
<br />
<strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-19106619524469180012011-09-11T16:53:00.003+08:002011-09-11T16:58:52.560+08:00Historical Volatility – Part 7: Comparing HVGo back to <a href="http://optionstradingbeginner.blogspot.com/2011/08/historical-volatility-part-6.html">Part 6: Interpretation</a>.<br /><br />One other way to use the HV data is by comparing the values among different stocks, as well as for a particular stock.<br />Here are some of the possible ways and its purpose/use:<br /><br /><strong>1) Comparing the HVs among different stocks.</strong><br />Although the volatility always fluctuates, it tends to oscillate around some “normal” value over long period of time, which can be deemed as its “average” value. When the volatility is relatively high or low, it would then move back or reverse towards its average value.<br />Therefore, we can use the <strong>average value</strong> of HV to compare between the volatility of one stock with the other, in order to estimate whether the stock is relatively “<strong>more volatile</strong>” or “riskier” than the other.<br />A stock with higher HV is considered to be a “more volatile” or “riskier” stock than that with lower HV.<br /><br /><strong>2) Comparing the HV of a particular stock a particular point of time with its own average HV value.</strong><br />As mentioned earlier, the volatility of a stock will always keep fluctuating.<br />Comparing the HV of a particular stock a certain point of time with its own average HV value will allow us to <strong>what has happened</strong> to the stock price.<br />When the HV is high, that means the stock has been showing extreme fluctuations in price during the period.<br />When the HV is low, that means the stock has been in quiet or sideways trading during the period.<br /><br /><strong>3) Comparing the HV of a particular stock in different period used for calculation.<br /></strong>Comparing the HV of a particular stock in different period can help to determine whether the volatility is rising or falling.<br />For example:<br />If the 30-day HV of a stock is 50% and 10-day HV of a stock is 15%, it suggests that the stock has recently experienced a sharp decline in volatility.<br /><br />To view the list of all the series on “Historical Volatility”, please refer to: “<a href="http://optionstradingbeginner.blogspot.com/2010/10/more-understanding-of-historical.html">More Understanding about HISTORICAL VOLATILITY</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-86877462006479334102011-08-23T19:08:00.013+08:002011-08-23T19:34:56.053+08:00Historical Volatility – Part 6: InterpretationGo back to <a href="http://optionstradingbeginner.blogspot.com/2011/05/historical-volatility-part-5-how-to.html"><strong>Part 5: How To Annualise Standard Deviation</strong></a>.
<br />
<br />After we know the definition and how to calculate HV, we’ll move on to its interpretation.
<br />
<br /><u>Example:</u>
<br />If it is known that the value of HV is 35%. Remember that this HV value is annualised, i.e. for one year.
<br />As mentioned in the earlier post, assuming that price returns are normally distributed, about two-third of the time, an individual return would fall within one standard deviation of the mean, and about 95% of the time, an individual return would fall within two standard deviation of the mean.
<br />
<br />That means, we can interpret that in one year, approximately two-thirds of the time, the stock returns would be between minus 35% and plus 35%. Or about 95% of the time, the stock return would be between minus 70% (= 2*35%) and plus 70%.
<br />
<br />If the stock price is $100, in one year, the price would probably be between $65 and $135 about two-thirds of the time. Or about 95% of the time, the stock price would be within $30 to $170 range.
<br />
<br /><u>How about for <strong>one month</strong>?</u>
<br />Since the annualised HV is 35%, the estimated value of standard deviation for one month will be:
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg__YAi_Uun7RtAaX85cJEdrFEpgUJpy5AcRxF3-cc00SH9sQTMakMln2lBt1FhZFr3pYRnyiGaesy4tdNjnFctN-iW_4LLvsmwyGaigNi6Pph1VVCLLjKYDX6-UQqFg1U5c_HqF85qsYw/s1600/HV_Part6_F1.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 173px; FLOAT: left; HEIGHT: 57px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5644008528505846066" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg__YAi_Uun7RtAaX85cJEdrFEpgUJpy5AcRxF3-cc00SH9sQTMakMln2lBt1FhZFr3pYRnyiGaesy4tdNjnFctN-iW_4LLvsmwyGaigNi6Pph1VVCLLjKYDX6-UQqFg1U5c_HqF85qsYw/s400/HV_Part6_F1.gif" /></a>
<br />
<br />
<br />
<br />That means, in one month, approximately two-thirds of the time, the stock returns would be between minus 10% and plus 10%. Or about 95% of the time, the stock return would be between minus 20% (= 2*10%) and plus 20%.
<br />
<br />If the stock price is $100, in one month, the price would probably be between $90 and $110 about two-thirds of the time. Or about 95% of the time, the stock price would be within $80 to $120 range.
<br />
<br /><u>How about for <strong>10 days</strong>?</u>
<br />With the annualised HV of35%, the estimated value of standard deviation for 10 days will be:
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBSvcflQdthEJ068dFPxppUUAwlGm2xA2ZqGqVURJrHW7xQ6NoNgQpKCQqketYNu0-kb2rQBVH5r5LRHUHFBEwtM4QgbOwtcTOSygwHXh9aBi0m4kSN8DObwzURgM3Ruh3kfSGLxscVSA/s1600/HV_Part6_F2.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 201px; FLOAT: left; HEIGHT: 81px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5644009152316906946" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBSvcflQdthEJ068dFPxppUUAwlGm2xA2ZqGqVURJrHW7xQ6NoNgQpKCQqketYNu0-kb2rQBVH5r5LRHUHFBEwtM4QgbOwtcTOSygwHXh9aBi0m4kSN8DObwzURgM3Ruh3kfSGLxscVSA/s400/HV_Part6_F2.gif" /></a>
<br />
<br />
<br />
<br />
<br />That means, in 10 days time, approximately two-thirds of the time, the stock returns would be between minus 7% and plus 7%. Or about 95% of the time, the stock return would be between minus 14% (= 2*7%) and plus 14%.
<br />
<br />If the stock price is $100, in 10 days, the price is expected to be between $93 and $107 about two-thirds of the time. Or about 95% of the time, the stock price would be within $86 to $114 range.
<br />
<br /><u>Note:</u>
<br />Some people use the following formula to convert:
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhW8T89u3lvTvLYN2FTFWQWjr3DsWZ-G55pUgpAkV_I3caJp16CpqMie-6mYc9bnbgpLOzgbCjDB8quCnGu9dSWajg95vlZHPPnLtno12kNUr8ZKhKsZIEf2bD5z6aD2EX8whDWFd8QUXk/s1600/HV_Part6_F3.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 189px; FLOAT: left; HEIGHT: 60px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5644009593973839346" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhW8T89u3lvTvLYN2FTFWQWjr3DsWZ-G55pUgpAkV_I3caJp16CpqMie-6mYc9bnbgpLOzgbCjDB8quCnGu9dSWajg95vlZHPPnLtno12kNUr8ZKhKsZIEf2bD5z6aD2EX8whDWFd8QUXk/s400/HV_Part6_F3.gif" /></a>
<br />
<br />
<br />
<br />This formula is actually the same as the above formula.
<br />This formula is based on the one mentioned in Wikipedia, as discussed in the earlier post (Part 5).
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgNpaswXa1HJRd5mhOZLt72ipwBNpDiollLRp0WuSE4PE7NkoCjGDITsAOELAYikHUYG3M4ItXpmA9RWCNgVACyvRfPEam6My8vZvvPSA2k8H9dalRKS2LwLF549d93sS_v-QZ__xO7mY/s1600/HV_Part6_F4.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 390px; FLOAT: left; HEIGHT: 165px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5644009895048292002" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgNpaswXa1HJRd5mhOZLt72ipwBNpDiollLRp0WuSE4PE7NkoCjGDITsAOELAYikHUYG3M4ItXpmA9RWCNgVACyvRfPEam6My8vZvvPSA2k8H9dalRKS2LwLF549d93sS_v-QZ__xO7mY/s400/HV_Part6_F4.gif" /></a>
<br />
<br />
<br />
<br />
<br />
<br />
<br />
<br />
<br />Continue to <strong>Part 7: Comparing HV</strong>.
<br />
<br />To view the list of all the series on “Historical Volatility”, please refer to: “<a href="http://optionstradingbeginner.blogspot.com/2010/10/more-understanding-of-historical.html">More Understanding about HISTORICAL VOLATILITY</a>”
<br />
<br /><strong><u>Other Learning Resources:</u></strong>
<br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a>
<br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a>
<br />
<br /><strong><u>Related Topics:</u></strong>
<br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a>
<br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a>
<br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a>
<br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a>
<br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a>
<br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>
<br />OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-56000844519980291762011-05-26T15:03:00.014+08:002011-05-26T15:50:47.240+08:00Historical Volatility – Part 5: How To Annualise Standard DeviationGo back to <a href="http://optionstradingbeginner.blogspot.com/2011/03/historical-volatility-part-4_31.html">Part 4: Understanding Standard Deviation</a><br /><br />As mentioned earlier, Historical Volatility is actually a standard deviation. The standard deviation can be calculated using historical price data in terms of daily, weekly, monthly, quarterly or yearly.<br /><strong>Historical Volatility</strong> is then expressed in terms of <strong>annualised</strong> standard deviation of % price returns, so that it can be compared across different stocks, regardless of the stock price and period used for HV calculation.<br /><br />The formula to annualise the Standard Deviation (that may be calculated using either daily, weekly, monthly, quarterly or yearly) is as follow:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6p9RQBbLQpPUyBgF4dvODcBmvP1B7fKD4fW32dM-fE1eACfWXp8DnFB3wFiiOB2XZT_j0fwaX9-6WajEDTVKIjtizvMm5r9j3mXd6RQuG2otgZ8qV-8-HIjZwB0Qu_VEC2NfCburIRAg/s1600/HV+Conversion_Formula1.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 477px; FLOAT: left; HEIGHT: 38px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610917962104778930" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6p9RQBbLQpPUyBgF4dvODcBmvP1B7fKD4fW32dM-fE1eACfWXp8DnFB3wFiiOB2XZT_j0fwaX9-6WajEDTVKIjtizvMm5r9j3mXd6RQuG2otgZ8qV-8-HIjZwB0Qu_VEC2NfCburIRAg/s400/HV+Conversion_Formula1.gif" /></a><br /><br />Where:<br />HV = Historical Volatility (annualised)<br />Sigma = Standard Deviation for a particular time period<br />T = <strong>Number of times (count)</strong> of such time periods in a year<br /><br />So, the value of T in the above formula will depend on the time period of the data used.<br /><br />In the example used in Part 3, we use daily price returns to calculate standard deviation. Assuming there are 252 trading days in a year, the value of T = 252 / 1 day = 252, because there are 252 times of 1-day period in a year. Hence, we can annualise it by using the following formula:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_b95KQ9WdhA7iDE4FZPsen4RU-x4Slq03K5eo2xeJp-QKgueqLC41tK_qaLXfj9q_IzzS-aXPhti0DoQyOKplFWSvB_9J6BfAxVOcjuvZA6ReJ4338RUpdw-ZMTKXNjfzaEIL5q-It3I/s1600/HV+Conversion_Formula2.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 473px; FLOAT: left; HEIGHT: 39px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610918274500905698" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_b95KQ9WdhA7iDE4FZPsen4RU-x4Slq03K5eo2xeJp-QKgueqLC41tK_qaLXfj9q_IzzS-aXPhti0DoQyOKplFWSvB_9J6BfAxVOcjuvZA6ReJ4338RUpdw-ZMTKXNjfzaEIL5q-It3I/s400/HV+Conversion_Formula2.gif" /></a><br /><br />Just for the sake of giving more examples for better understanding of the value of T.<br />Suppose that 3-day price return data (i.e. the closing prices for every 3 days) is used to calculate the standard deviation. In this case, the value of T = 252 / 3 days = 84, because there are 84 times of 3-day period in a year. Hence, the formula will be:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxy12GTSUjlNTqUZ-BCHlfF3z0pKTXsx7l-5IHVz0mjqeu7GnvWMpbejTP0yWdCQif9gSJ5l-2hBKub9Ua9W3h5Zt4QSgw7qqXqrr5CT5A-vDiWm6xLu-SDZJONAxntIkqbEmaRR_-7VU/s1600/HV+Conversion_Formula3.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 487px; FLOAT: left; HEIGHT: 57px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610918913316691394" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxy12GTSUjlNTqUZ-BCHlfF3z0pKTXsx7l-5IHVz0mjqeu7GnvWMpbejTP0yWdCQif9gSJ5l-2hBKub9Ua9W3h5Zt4QSgw7qqXqrr5CT5A-vDiWm6xLu-SDZJONAxntIkqbEmaRR_-7VU/s400/HV+Conversion_Formula3.gif" /></a><br /><br />In the case of monthly data is used (i.e. using month-end closing prices), the value of T will be 12 because there are 12 months in a year. Hence, the formula to annualise the monthly data is as follow:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkwiL487rgWvmF9Kkj-_6hKYDwuQWEECtYYHA2TLKpy-kEGjOkARPOj87llCUo_xvWadJP94PwXfDSyamZgOU9-euPNrAWBwsJsH8OjbgXCfxE3tkQCy0b5Rs_X3g3Qhtxx5kJSUFV7CI/s1600/HV+Conversion_Formula4.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 487px; FLOAT: left; HEIGHT: 36px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610920123967061154" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkwiL487rgWvmF9Kkj-_6hKYDwuQWEECtYYHA2TLKpy-kEGjOkARPOj87llCUo_xvWadJP94PwXfDSyamZgOU9-euPNrAWBwsJsH8OjbgXCfxE3tkQCy0b5Rs_X3g3Qhtxx5kJSUFV7CI/s400/HV+Conversion_Formula4.gif" /></a><br />For example:<br />If it is known that the “monthly” standard deviation of Stock ABC’s price returns is 15%, its Historical Volatility will be:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiX_v45WNFiYqt7kvgHyQVHq4KBDBJ82e5QDEfW88EOk05LyF0I1XncqBvgZd3IW7000mGnCavbRGBl7FOss9C-OY-YoumgZTwKlmrGzek39NMKStqWZCGANDTgz9wFIY6DkbC3XG1V5TU/s1600/HV+Conversion_Formula4a.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 487px; FLOAT: left; HEIGHT: 38px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610920768637190898" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiX_v45WNFiYqt7kvgHyQVHq4KBDBJ82e5QDEfW88EOk05LyF0I1XncqBvgZd3IW7000mGnCavbRGBl7FOss9C-OY-YoumgZTwKlmrGzek39NMKStqWZCGANDTgz9wFIY6DkbC3XG1V5TU/s400/HV+Conversion_Formula4a.gif" /></a><br /><br /><br />Note:<br />In Wikipedia, the formula to annualise the standard deviation is as follow:<br />http://en.wikipedia.org/wiki/Volatility_(finance)<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNacT4XzcVP-iXt2-OdumbDAFXNt56JOMnA_POWhiYDXIPS3WvRTZMtr9xwLl6QqxJ91dQm6m8NRnlxkQHT13RnrLU24VoDn4D7UVQv4SBVpNwOWzylXjHLP-tw1RzvrPPXBbx5Kq61_8/s1600/HV+Conversion_Formula5.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 487px; FLOAT: left; HEIGHT: 56px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610921163426231586" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNacT4XzcVP-iXt2-OdumbDAFXNt56JOMnA_POWhiYDXIPS3WvRTZMtr9xwLl6QqxJ91dQm6m8NRnlxkQHT13RnrLU24VoDn4D7UVQv4SBVpNwOWzylXjHLP-tw1RzvrPPXBbx5Kq61_8/s400/HV+Conversion_Formula5.gif" /></a><br /><br />Where:<br />Sigma = Annualised Volatility<br />Sigma SD = Standard Deviation for a particular time period<br />P = <strong>Time period of returns</strong> (expressed in terms of year)<br /><br />To annualise a daily (i.e. 1 day) standard deviation, the value of P will be 1/252 (i.e. 1 day expressed in terms of year). So, the formula will be:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhl5_rjvvFbFSbLyYtW-hE_xb5OKfpWg6WzN6SABX85SbOWBj0dn7ooP98TVMirnBuMT2EAqss408AMT86Dndcg9UXkjHcNDvbBkuFPDpgtp1OSCxsnuS8MJNz_vsJDR-dkE2WrNNeaaPU/s1600/HV+Conversion_Formula6.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 479px; FLOAT: left; HEIGHT: 78px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610921616404677794" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhl5_rjvvFbFSbLyYtW-hE_xb5OKfpWg6WzN6SABX85SbOWBj0dn7ooP98TVMirnBuMT2EAqss408AMT86Dndcg9UXkjHcNDvbBkuFPDpgtp1OSCxsnuS8MJNz_vsJDR-dkE2WrNNeaaPU/s400/HV+Conversion_Formula6.gif" /></a><br /><br /><br />This Formula (6) is actually the same as Formula (2), because:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_eWUkWOEviPK82Cak0vkZOB9KFelI1UBTDpgtkL3QJdnSsFKT9bJj_V8-3Y_Sm6PwgUgXcfdBhSnXqArwV364ZdOTUdWbIQsQ27Ti4BcMlS24DN3jHqsjh1dGgEpGveQx5r2qlhgGwE8/s1600/HV+Conversion_Formula6a.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 480px; FLOAT: left; HEIGHT: 83px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5610922210607509810" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_eWUkWOEviPK82Cak0vkZOB9KFelI1UBTDpgtkL3QJdnSsFKT9bJj_V8-3Y_Sm6PwgUgXcfdBhSnXqArwV364ZdOTUdWbIQsQ27Ti4BcMlS24DN3jHqsjh1dGgEpGveQx5r2qlhgGwE8/s400/HV+Conversion_Formula6a.gif" /></a><br /><br /><br />I found some people had commented that the formula in Wikipedia is not right. Actually, the formula is right. But we should understand what the logic is and understand the “definition” for the variables. Do compare the definition for T and P, and notice when we should multiply or divide when we want to annualise from daily standard deviation or to convert the annualised standard deviation into daily standard deviation. Just choose one that can make more sense to you.<br /><br />Continue to <strong>Part 6: Interpretation<br /></strong><br />To view the list of all the series on “Historical Volatility”, please refer to: “<a href="http://optionstradingbeginner.blogspot.com/2010/10/more-understanding-of-historical.html">More Understanding about HISTORICAL VOLATILITY</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-80961209613359912392011-03-31T12:12:00.004+08:002011-05-26T15:35:04.962+08:00Historical Volatility – Part 4: Understanding Standard DeviationGo back to <strong><a href="http://optionstradingbeginner.blogspot.com/2011/02/historical-volatility-part-3-steps-to.html">Part 3: Steps to Calculate HV using MS Excel (with Example)</a></strong><br /><br />As Historical Volatility (HV) is calculated using standard deviation, it might be good to understand better about the concept of standard deviation, so that we can interpret the meaning of HV better.<br /><br />Standard deviation is a measure of data variability or dispersion (i.e. how spread out the data points from its mean).<br />When the standard deviation is <strong>low</strong>, that means the data points tend to be very close to its mean (i.e. the data is spread out over a small range of values).<br />When the standard deviation is <strong>high</strong>, that means the data points tend to be far away from its mean (i.e. the data is spread out over a large range of values).<br /><br />This can be understood from the formula below as well:<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgM_swDKTHxr1kSBS4ByuDnLiDlWU7FZ5CMv2Y4DK3WQ3-aAANJuCo0nI1MlwWAWQ52WnS_fUqP9pkq4gwSd9N3s1_cbbX-y2DtMRS3Z1dnOAFsetdyM7iTtT09fG1rP9vQXRIeiv2-FHM/s1600/HV_StdDevFormula.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 152px; FLOAT: left; HEIGHT: 99px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5589054296883857618" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgM_swDKTHxr1kSBS4ByuDnLiDlWU7FZ5CMv2Y4DK3WQ3-aAANJuCo0nI1MlwWAWQ52WnS_fUqP9pkq4gwSd9N3s1_cbbX-y2DtMRS3Z1dnOAFsetdyM7iTtT09fG1rP9vQXRIeiv2-FHM/s400/HV_StdDevFormula.gif" /></a><br /><br />The <strong>numerator</strong> in the formula is the summation of the difference between individual data point and the mean of the data set.<br /><br />If the data points tend to be very close to its mean (less spread out from the mean value), the difference between each individual data point and the mean would be relatively small, and hence the summation of all differences and, in turn, the standard deviation will be small too.<br /><br />On the other hand, if the data points tend to be far away from its mean (more spread out from the mean value), the difference between each individual data point and the mean would be bigger, and hence the summation of all differences and, in turn, the standard deviation will be big too.<br /><br />In <strong>denominator</strong>, “n – 1” is used instead of “n” to get an unbiased estimator, because this standard deviation is derived based on sample, not population. (If the population is used, then the dominator will be “n”).<br />Since the standard deviation is estimated based on sample, using “n – 1” as the denominator will “inflate” the standard deviation value to “capture more risks” due to estimating the standard deviation based on sample only instead of population. (Remember that to estimate HV, we’ll never be able to use “population”).<br />This adjustment is particularly essential when we estimate the standard deviation based on a small number of observations (i.e. when n is relatively small). However, when n is big, the difference between using “n – 1” or “n” is not very significant.<br /><br /><strong><u>Standard Deviation of Normal Distribution</u></strong><br />One important attribute of the standard deviation is that in a Normal Distribution, about 66.8% (two third) of the data are within one standard deviation of the mean, and about 95% of the data are within two standard deviations of the mean.<br /><br />In Historical Volatility, price returns are assumed to be normally distributed, like shown in the picture below.<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifyQ07Q2u71coz-K8p9l9mczKeyiJGofrJSIw929Men9WzechQiqqJikfO18_0pOdPSscf29KJSTuwGfE2R28vMxNzxTakyRFn-s11rKfRcPA2OpOxqxq0yPw9qwWrPg14e3qsszq3Bfo/s1600/HV_NormalDist.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 400px; FLOAT: left; HEIGHT: 214px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5589054479249024402" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifyQ07Q2u71coz-K8p9l9mczKeyiJGofrJSIw929Men9WzechQiqqJikfO18_0pOdPSscf29KJSTuwGfE2R28vMxNzxTakyRFn-s11rKfRcPA2OpOxqxq0yPw9qwWrPg14e3qsszq3Bfo/s400/HV_NormalDist.gif" /></a><br /><br />Source of picture: http://www.russell.com/us/glossary/analytics/standard_deviation.htm<br /><br />Therefore, about two-third of the time, an individual return would fall within one standard deviation of the mean, and about 95% of the time, an individual return would fall within two standard deviation of the mean.<br /><br />Continue to <strong><a href="http://optionstradingbeginner.blogspot.com/2011/05/historical-volatility-part-5-how-to.html">Part 5: How To Annualise Standard Deviation</a> </strong><br /><br />To view the list of all the series on “Historical Volatility”, please refer to: “<a href="http://optionstradingbeginner.blogspot.com/2010/10/more-understanding-of-historical.html">More Understanding about HISTORICAL VOLATILITY</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com5tag:blogger.com,1999:blog-2092963398381163069.post-81569306668448233912010-11-17T18:37:00.018+08:002010-11-17T19:36:34.620+08:00Historical Volatility – Part 2: Formula to Calculate HVGo back to <a href="http://optionstradingbeginner.blogspot.com/2010/10/historical-volatility-part-1-definition.html">Part 1: Definition of Historical Volatility<br /></a><br />As mentioned in Part 1, to obtain Historical Volatility, we need to calculate the standard deviation of the price returns using historical data (which can be in terms of daily, weekly, monthly, quarterly or yearly) over a certain period.<br />Commonly, the daily price data for the period of 10 days, 20 days, or 30 days are used.<br /><br />Theoretically, the <strong>formula</strong> to calculate <strong>Historical Volatility</strong> (i.e. standard deviation of % stock’s returns) is as follow:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtspM_Ln3S86RFP8ITOUNnDE-yq57VhuRHvthwsiSdlWcXg5ArAYCkcHS6rI6tYAM-Y1uM-8K6PthYBIecEgZI3SltUYsgKbe0CAQiKl-F77WCDmL8RwTU1O-xgbt_m1kLt_8nn2ZvAig/s1600/HV+Formula1.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 405px; FLOAT: left; HEIGHT: 448px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5540473343441583058" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtspM_Ln3S86RFP8ITOUNnDE-yq57VhuRHvthwsiSdlWcXg5ArAYCkcHS6rI6tYAM-Y1uM-8K6PthYBIecEgZI3SltUYsgKbe0CAQiKl-F77WCDmL8RwTU1O-xgbt_m1kLt_8nn2ZvAig/s400/HV+Formula1.gif" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEinyxsPZvmJM91a0WUG1hdEtPSb_6Yp3KYEGeJhQPfyWHmdLpUcyumgI9Cj01t3cKD15xNXolywb1_mlP5O_AGEzuf7bnKzRyv0_Ve-7_evjWULJECfHuKzuLSHRy-WINAjTgpx0IEwDPs/s1600/HV+Formula1.gif"></a><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKnXbXtmppnEgyK59T89WyVMB11Ad11laQTmIWhJHDgS5KgUWkXxvM0OVvQ67j-IdkV7zDhoFqYQy6i-4KAc9F0AshlNtBBA_uDe__4LhD9xL6W7LB_htdZCwpYsv3PBm1PbQriBPIfZY/s1600/HV+Formula2.gif"></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGoWiCgk8y1P7FxGmRvubq9Pl-ULKAv-uARaVtpVBtSISS8S5lX75JzZgf-3a8xaRmeRm9egfBrfRLfpU5wVQOfkoaREzWD4HklAzGdcD4pdiSu1BHes5XL1-IVF4ahTJ84xmwR18FmX4/s1600/HV+Formula2.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 403px; FLOAT: left; HEIGHT: 213px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5540470618087674418" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGoWiCgk8y1P7FxGmRvubq9Pl-ULKAv-uARaVtpVBtSISS8S5lX75JzZgf-3a8xaRmeRm9egfBrfRLfpU5wVQOfkoaREzWD4HklAzGdcD4pdiSu1BHes5XL1-IVF4ahTJ84xmwR18FmX4/s400/HV+Formula2.gif" /></a><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br />After the standard deviation is calculated, we then need to annualize it.<br />To annualise the Standard Deviation resulted from formula (1) in order to get Historical Volatility (HV):<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiFDsRjXcnu3IszfOjqkfwnHoTFLjEg7Wk0-TQ6U3icntvOtHkTGmZXIQ_FrdU2-9qLSW4Q-2zcYQrkMXMxRXp0O7lyjFRaXvcIZ9-4OfZDKRl3sF3kmjrFz0-vOs6Y0toMcbf7VByDeg/s1600/HV+Formula3.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 303px; FLOAT: left; HEIGHT: 135px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5540470874414517506" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiFDsRjXcnu3IszfOjqkfwnHoTFLjEg7Wk0-TQ6U3icntvOtHkTGmZXIQ_FrdU2-9qLSW4Q-2zcYQrkMXMxRXp0O7lyjFRaXvcIZ9-4OfZDKRl3sF3kmjrFz0-vOs6Y0toMcbf7VByDeg/s400/HV+Formula3.gif" /></a><br /><br /><br /><br /><br /><br /><br /><br />The formula above may look complicated. However, they are actually quite simple with the help of MS Excel to calculate it.<br />We’ll discuss it further along with the example in the next part.<br /><br />Continue to <strong>Part 3</strong>: Steps to Calculate HV using MS Excel (with Example).<br /><br />To view the list of all the series on “Historical Volatility”, please refer to:<br />“<a href="http://optionstradingbeginner.blogspot.com/2010/10/more-understanding-of-historical.html">More Understanding about HISTORICAL VOLATILITY</a>”<br /><br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-49498746995121111172010-10-31T18:42:00.007+08:002010-11-17T19:37:52.284+08:00Historical Volatility – Part 1: Definition<strong>Historical Volatility (HV)</strong> is a measure of the fluctuations of the stock price (i.e. how volatile the prices had fluctuated) over a certain period of time in the <strong>past</strong>.<br /><br />Suppose the daily closing prices of Stock X and Y for the past 10 days are shown as follows:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiyQ3CEmRPjnou4OAz76OTfZ2KehftwDpuXciY-KC4EQQvJI1lshFdXaPjA4zk7CEmLVW1C-6H_kKHYvB1hFd-VnCUrIISyS1NZL7cUwRCH5y7wt2ZdGsUnG_mxkO2WtSF3sZZULmoYPSw/s1600/HV_StockXY.gif"><img style="MARGIN: 0px 10px 10px 0px; WIDTH: 358px; FLOAT: left; HEIGHT: 285px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5534162445035134962" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiyQ3CEmRPjnou4OAz76OTfZ2KehftwDpuXciY-KC4EQQvJI1lshFdXaPjA4zk7CEmLVW1C-6H_kKHYvB1hFd-VnCUrIISyS1NZL7cUwRCH5y7wt2ZdGsUnG_mxkO2WtSF3sZZULmoYPSw/s400/HV_StockXY.gif" /></a><br />As can be seen from the data above, regardless of the direction (up or down), the closing prices of Stock X in the past 10 days have fluctuated / changed by $2 to $5, whereas Stock Y by $1 to $3.<br />Since given the same initial stock price of $100, Stock X has shown bigger fluctuation in terms of dollar, Stock X is said to be more volatile than Stock Y.<br /><br />Now, suppose Stock Z has an initial stock price of $50 and has also fluctuated by $2 to $5 like Stock X. In this case, given the same fluctuation in terms of dollar but lower stock price than Stock X, Stock Z will be considered to be more volatile than Stock X.<br />Hence, to get relative measurement of volatility and to compare volatilities among stocks with different prices, it is more accurate to reflect the price change in terms of <strong>percentage</strong> of the stock price, which is known as “<strong>Price Returns</strong>”.<br /><br />Historical Volatility (HV) is therefore obtained by calculating the <strong>standard deviation</strong> of <strong>historical</strong> price changes (i.e. price <strong>returns</strong>) over a specified period in the past.<br /><br />In Statistics, <strong>Standard Deviation</strong> measures the dispersion (spread) of a set of data points from its mean (average).<br />The more disperse (spread out) the data points from its mean, the higher the standard deviation. This deviation is referred by traders as “volatility”.<br />(Note: Further understanding about standard deviation will be discussed in the future article).<br /><br />The higher the historical volatility, the bigger fluctuation the stock has experienced. As such, theoretically, the more likely the stock may make big movement in the future too, although this does not give any insight about the trend / which direction it will move to.<br /><br />Depending of its uses/purposes or data availability, for calculation of HV, we can use historical price data in terms of daily, weekly, monthly, quarterly or yearly.<br />The common period used to calculate HV is 10 days, 20 days, or 30 days (using daily data).<br />To allow comparison between volatilities that are calculated using different period, the HV would be <strong>annualized</strong>.<br /><br />By expressing HV using annualised standard deviation of % price returns, the figures can be used to compare the volatility across different stocks, regardless of the stock price and the period used for HV calculation.<br /><br />In conclusion, Historical Volatility can be defined as follow:<br /><br /><em><strong>Historical Volatility (HV)</strong> is the <strong>annualised standard deviation</strong> of <strong>historical</strong> price changes (i.e. <strong>returns</strong>) over a specified period in the <strong>past</strong>.<br /></em><br />In the next posts, we will discuss:<br />* Formula to calculate HV<br />* Steps to calculate HV using MS Excel (with example)<br />* Further understanding about Standard Deviation<br /><br />Continue to <a href="http://optionstradingbeginner.blogspot.com/2010/11/historical-volatility-part-2-formula-to.html"><strong>Part 2</strong>: Formula to Calculate Historical Volatility</a>.<br /><br />To view the list of all the series on “Historical Volatility”, please refer to:<br />“<a href="http://optionstradingbeginner.blogspot.com/2010/10/more-understanding-of-historical.html">More Understanding about HISTORICAL VOLATILITY</a>”<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br /><br /><strong><u>Related Topics:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com1tag:blogger.com,1999:blog-2092963398381163069.post-88093193387308305072010-10-16T08:47:00.012+08:002015-04-26T16:36:43.601+08:00More Understanding of HISTORICAL VOLATILITYIn the <a href="http://optionstradingbeginner.blogspot.com/2007/08/historical-volatility-hv-vs-implied.html">previous article</a>, we had explained what <strong>Historical Volatility</strong> is very briefly. In these series, in order to gain better understanding and hence be able to interpret its meaning better, we’ll discuss more in-depth about Historical Volatility. As usual, I’ll try to share my understanding about this topic as simple as possible, so that it’ll be easier to understand for everyone.<br />
Click the following link to read each article:<br />
<br />
1) <a href="http://optionstradingbeginner.blogspot.com/2010/10/historical-volatility-part-1-definition.html">Definition of Historical Volatility</a><br />
2) <a href="http://optionstradingbeginner.blogspot.com/2010/11/historical-volatility-part-2-formula-to.html">Formula to calculate HV</a><br />
3) <a href="http://optionstradingbeginner.blogspot.com/2011/02/historical-volatility-part-3-steps-to.html">Steps to calculate HV using MS Excel (with example)</a><br />
4) <a href="http://optionstradingbeginner.blogspot.com/2011/03/historical-volatility-part-4_31.html">Understanding Standard Deviation </a><br />
5) <a href="http://optionstradingbeginner.blogspot.com/2011/05/historical-volatility-part-5-how-to.html">How to annualise Standard Deviation</a><br />
6) <a href="http://optionstradingbeginner.blogspot.com/2011/08/historical-volatility-part-6.html">Interpretation of Historical Volatility</a><br />
7) <a href="http://optionstradingbeginner.blogspot.com/2011/09/historical-volatility-part-7-comparing.html">Comparing HV </a><br />
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<strong><u>Other Learning Resources:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />
* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos from Trading Experts</a><br />
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<strong><u>Related Topics:</u></strong><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Understanding Option Greek</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />
* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0tag:blogger.com,1999:blog-2092963398381163069.post-59810644256411695012010-10-10T19:06:00.002+08:002010-10-10T19:11:19.535+08:00Market Analysis Video: This Reliable S&P Formation Could Make You Money<a href="http://www.ino.com/info/636/CD3182/&dp=0&l=0&campaignid=3">This short video on the S&P 500</a> is worth watching. It shows a detailed analysis on a particular chart formation that has proven to be very reliable in the past. If the analysis is right, we couldsee a further move and run in the S&P500 to the upside.<br />Check it out!<br /><br /><strong><u>Other Learning Resources:</u></strong><br />* <a href="http://optionstradingbeginner.blogspot.com/2010/01/new-free-trading-videos-with-special.html">FREE Trading Educational Videos with Special Feature</a><br />* <a href="http://www.ino.com/info/206/CD3182/&dp=0&l=0&campaignid=9">FREE Trading Educational Videos: Learn Technical Analysis from Award Winning Author John Murphy</a><br /><br /><strong><u>Related Topics:</u><br /></strong>* <a href="http://optionstradingbeginner.blogspot.com/2010/05/head-and-shoulders-bottom-pattern-part.html">Understanding HEAD & SHOULDERS BOTTOM Pattern<br /></a>* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basics.html">Options Trading Basic – Part 1</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/04/options-trading-basic-part-2.html">Options Trading Basic – Part 2</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/09/understanding-implied-volatility-iv.html">Understanding Implied Volatility (IV)</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/07/option-greeks.html">Option Greeks</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2009/04/understanding-options-time-value.html">Understanding Option’s Time Value</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/12/chart-patterns.html">Learning Charts Patterns</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/10/learning-understanding-candlestick.html">Learning Candlestick Charts</a><br />* <a href="http://optionstradingbeginner.blogspot.com/2007/06/getting-started-trading.html">Getting Started Trading</a>OPTIONS TRADING BEGINNERhttp://www.blogger.com/profile/12902119875170352315noreply@blogger.com0